MANAGEMENT SCIENCE

DECISION
THEORY

BUILDING A WINNING BUSINESS

Presented By:

BACATANO, RITCHE LYN B.

FERANGCO, MORRIS M.

ROSALES, CATHERINE JOY R.

INTRODUCTION

WHAT IS DECISION THEORY?

It is a body of knowledge and related analytical techniques

of different degrees of formality designed to help the decision-

maker choose from a set of alternatives in light of their

possible consequences

CONDITIONS IN DECISION

MAKING

Decision Making Under Conditions of

Uncertainty

Decision Making Under Conditions Under

Risk

Marginal Analysis With Discrete

Distribution

Marginal Analysis With Normal

Distribution
THE CONCEPT OF

PROBABILITY

Probability is the chance of something happening. It

may be expressed as fraction, decimal, or as a

percentage.

The probability of an event ranges from 0 to 1; when a

probability of 0 (zero) is assigned, it means that

something can never happen.

When a probability of 1 is assigned, it means that

something will occur with certainty.

The probability of occurrence of the event is called

success and the probability of non occurrence is

called failure.

The probability of success is 1 to 100%.

 EXPECTED VALUE ( EV) OR
MATHEMATICAL EXPECTATION ( ME )

The Expected Value (EV)—also called Mathematical

Expectation (ME)—is the weighted average of all possible

outcomes, where each outcome is multiplied by its probability. It is

the product of the probability that an event will occur and the

amount to be received upon such an occurrence.

EXAMPLE:

FORMULA: The PSA construction operations manager is deciding

ME = P (X)

Wherein: whether to accept a bid.

P represents the probability value
If the bid is accepted, two outcomes are possible:
X represents the amount of money.

If the project succeeds, the company gains ₱3.5

It should always be a sum of 2 or more probabilities
million.
equivalent to 100%

If the project fails, the company loses ₱2.5 million.

The probability of success is 30%.

Find the mathematical expectation if the company

accepts the bid.

 SOLUTION
Step 1: Identify the values

We convert percentages to decimal probabilities and represent the outcomes:

Step 2: Apply the formula for Mathematical Expectation

Step 3: Perform Calculations

MATHEMATICAL EXPECTATION (ME) = - 700,000

DECISION THEORY

STEPS IN

DECISION MAKING
STEP 1 STEP 2 STEP 3

The decision-maker should construct

The decision-maker should
The first action that a decision-
enumerate all future events affecting the payoff table containing the

maker must do is to list all the the demand that may occur. It is relationship between pairs of decision

FEASIBLE alternatives that must easy to identify the future events

elements. This table also shows the
that can occur; the difficulty lies with
be considered in the decision payoff expressed in profit or any
knowing which particular event will
measure of benefit which is appropriate
occur. A future event which is not

controlled by the decision-maker is in a situation that results from each

called state of nature in decision possible combination of decision

theory.
alternatives and states of nature.
CONDITIONS IN
DECISION-MAKING

DECISION-MAKING UNDER CONDITIONS

OF UNCERTAINTY.

In this criterion, more than one state of nature exists but

the decision-maker has no knowledge of the various states

nor sufficient data to permit the assignment of probabilities

to the state of the nature. Therefore, decision-making is

uncertain because future events are very unpredictable.

DECISION-MAKING UNDER CONDITIONS

OF RISK.

In this situation, more than one state of nature exists,

but the decision-maker has information which will

support the assignment of probability to each of the

possible states. Decision-making is risky if one state can

happen out of a few possible states.

MARGINAL ANALYSIS WITH DISCRETE

DISTRIBUTION.

This condition is used if there are many alternatives

and states of nature. The following requirements must

be satisfied to use this analysis: the selling price and

marginal loss per unit are known; the alternative and

state of nature are identical; and the probability of

occurrence of each state of nature is known and

discrete.

MARGINAL ANALYSIS WITH NORMAL

DISTRIBUTION.

This condition is used when there are infinitely

many alternatives and states of nature. To use this

approach, the selling price and marginal loss per unit

must be known; the mean value should be indicated;

the standard deviation should be established; and the

probability distribution must be normal.

 MANAGEMENT SCIENCE

PRESENTATION - 2025

PROBLEM
SET
TOPIC

Decision Making Under Conditions of Uncertainty

Decision Making Under Conditions Under Risk

Marginal Analysis With Discrete Distribution

Prepared by:
Marginal Analysis With Normal Distribution

BACATANO, RITCHE LYN B.

FERANCO, MORRIS M.
ROSALES, CATHERINE JOY R.
123 Anywhere St., Any City, ST 12345 www.reallygreatsite.com
DECISION-MAKING UNDER

CONDITIONS OF UNCERTAINTY

MAXIMAX CRITERION

It makes one select an alternative that caries a maximum or the

highest payoff.

MAXIMIN CRITERION

It takes into account only the worst possible outcome for each

alternative. Decision makers try to maximize the minimum possible

payoff.

Maximax Criterion Maximin Criterion

MINIMAX CRITERION

This is the basis for choosing an alternative for decision-

makers who want to minimize opportunity of losses. Criterion of Realism or

Minimax Criterion
Hurwicz
CRITERION OF REALISM OR HURWICZ

Middle ground between maximax and maximin; that is,

between optimism and pessimism. This is a basis of Laplace

choosing alternatives for decision makers who use a

subjective assessment.

LAPLACE
presumes all alternative have an equal chance of occuring
DECISION-MAKING UNDER

CONDITIONS OF UNCERTAINTY

Julio Vera, the market analyst of Nestle is ask to present an expansion plan
for the company to the senior managers (Unah, Yana, Janina, Cara, and Cali).
The plan is either to construct a plant, open a distribution center, or do
nothing. He was able to determine the expected payoff depending on the
decision and the type of market which may be favourable, average, or
unfavourable to the business. From the plant construction, the company will
gain P80,000 if the market turns out to be favourable, lose P10,000 if the
market turns out to be average, and lose P50,000 if the market turns out to
be unfavourable. From opening a distribution center, the company will gain
P40,000 if the market turns out to be favourable, gain P20,000 if market
turns out to be average, and loss of P30,000 if market turns out to be
unfavourable. If the decision is to nothing, the company will gain nothing
regardless of the market turnout. The market analyst has noted that the
decision of each manager is affected by his/her personality. He described
each manager as follows:

1. Unah is optimistic manager.

2. Yana is a pessimistic or conservative manager.
3. Janina thinks that there is a 70% chance that market is available.
4. Cara thinks that each type of market has an equal chance of occurring.
5. Cali does not want to regret making a wrong decision.
 QUESTION:

What would be the decision of each manager?

How much gain or loss for the company would
each expect? Which alternative is most likely
to be chosen by each manager?
SOLUTION:
Solve the problem step by step.
Start by identifying and listing the states of nature and the alternatives.
Here, the alternative is the EXPANSION PLAN OF MARKET, that is, to construct a plant, open a distribution center,
or do nothing; and the state of nature is the TYPE OF MARKET which may be favourable, average, or unfavourable
Next is to construct a payoff table:

TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE AVERAGE UNFAVOURABLE

CONSTRUCT A PLANT 80,000 -10,000 -50,000

OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000

DO NOTHING 0 0 0

CRITERION A REALISM 70%

Note that a negative sign implies a loss to the company
SOLUTION- (MAXIMAX)
The next step is to solve the problem according to the personality attribute observed.
Consider the first manager, Unah, who is an optimistic person. Using the MAXIMAX criterion, determine the
maximum payoff per row corresponding to each alternative and find the maximum payoff of the maximum
column.
MANAGER UNAH DECISION CRITERION: MAXIMAX
TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMUM
FAVOURABLE AVERAGE UNFAVOURABLE
CONSTRUCT A PLANT 80,000 -10,000 -50,000 80,000
OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000 40,000
DO NOTHING 0 0 0 0
Maximum 80,000
DECISION: CONSTRUCT A PLANT

RECOMMENDATION: Unah will decide to construct a plant for she is expecting a payoff of P 80,000.
SOLUTION- (MAXIMIN)
Let us now proceed to the second manager, Yana, who is conservative or pessimistic.
Using the MAXIMIN criterion, determine minimum payoff per row corresponding to each alternative, and find the
maximum payoff of the minimum column.

MANAGER YANA DECISION CRITERION: MAXIMIN

TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMIN
FAVOURABLE AVERAGE UNFAVOURABLE
CONSTRUCT A PLANT 80,000 -10,000 -50,000 -50,000
OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000 -30,000
DO NOTHING 0 0 0 0
Maximum 0
DECISION: DO NOTHING

RECOMMENDATION: Manager Yana will do nothing and expect no payoff.

SOLUTION- ( CRITERION OF REALISM)
The third manager, Janina, is neither optimistic nor pessimistic and is just a realistic person.
Thus, Janina uses the CRITERION OF REALISM. Here, she has set a 70% chance that the market is favorable.
Compute the EV per row corresponding to each alternative and find the maximum payoff of the EV column.

ALTERNATIVES:

CONSTRUCT A PLANT

OPEN A DISTRIBUTION CENTER

DO NOTHING

RECOMMENDATION: Manager Yana will do nothing and expect no payoff.

SOLUTION- ( CRITERION OF REALISM)
The third manager, Janina, is neither optimistic nor pessimistic and is just a realistic person.
Thus, Janina uses the CRITERION OF REALISM. Here, she has set a 70% chance that the market is favorable.
Compute the EV per row corresponding to each alternative and find the maximum payoff of the EV column.

ALTERNATIVES:
MANAGER YANA DECISION CRITERION: CRITERION OF REALISM
TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMIN
FAVOURABLE AVERAGE UNFAVOURABLE
CONSTRUCT A PLANT 80,000 -10,000 -50,000 41,000
OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000 19,000
DO NOTHING 0 0 0 0
Maximum 41,000
DECISION: CONSTRUCT A PLANT
RECOMMENDATION: Manager Janina, using the criterion of realism, will decide to construct a plant with an expected
payoff of P41,000.
SOLUTION- ( LAPLACE)
The fourth manager, Cara, who thinks that all outcomes have an equal chance of occurring.
She belongs to the LAPLACE criterion.
In order to arrive at this decision, compute for the average payoff per row corresponding to each alternative and
find the maximum of the average column

MANAGER YANA DECISION CRITERION: CRITERION OF REALISM

TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMIN
FAVOURABLE AVERAGE UNFAVOURABLE
CONSTRUCT A PLANT 80,000 -10,000 -50,000 6,667
OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000 10,000
DO NOTHING 0 0 0 0
Maximum 10,000
DECISION: OPEN A DISTRIBUTION CENTER

RECOMMENDATION: Manager Cara will decide to open a distribution center and expect a payoff of P10,000.
SOLUTION- ( MINIMAX)
The fifth manager, Cali, wants to choose an alternative that will MINIMIZE LOSSES.
He will set up the MINIMAX criterion following these steps:
1. Find the maximum payoff per column corresponding to the TYPE OF MARKET.

TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE AVERAGE UNFAVOURABLE

Construct a Plant 80,000 -10,000 -50,000

Open a Distribution Center 40,000 20,000 -30,000

Do Nothing 0 0 0
SOLUTION- ( MINIMAX)
The fifth manager, Cali, wants to choose an alternative that will MINIMIZE LOSSES.
He will set up the MINIMAX criterion following these steps:

2. Compute the opportunity losses

TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE AVERAGE UNFAVOURABLE

Construct a Plant 80,000-80,000 20,000-(-10,000) 0- (-50,000)

Open a Distribution Center 80,000- 40,000 20,000 - 20,000 0- (-30,000)

Do Nothing 80,000-0 20,000-0 0

SOLUTION- ( MINIMAX)
The fifth manager, Cali, wants to choose an alternative that will MINIMIZE LOSSES.
He will set up the MINIMAX criterion following these steps:
3. Determine the maximum opportunity loss per row corresponding to each ALTERNATIVE

TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMUM OPPORTUNITY LOSS
FAVOURABLE AVERAGE UNFAVOURABLE

Construct a Plant

Open a Distribution Center

Do Nothing
SOLUTION- ( MINIMAX)
4. Identify the MINIMUM of the maximum opportunity loss column and create the MINIMAX

CRITERION TABLE and state the decision of Manager Cali.

MANAGER CALI DECISION CRITERION: MINIMAX

TYPE OF MARKET
EXPANSION PLAN PAYOFF MAXIMIN
FAVOURABLE AVERAGE UNFAVOURABLE
CONSTRUCT A PLANT 0 30,000 50,000 50,000
OPEN A DISTRIBUTION CENTER 40,000 20,000 30,000 40,000
DO NOTHING 80,000 20,000 0 80,000
Minimum 40,000
DECISION: OPEN A DISTRIBUTION CENTER

RECOMMENDATION: Manager Cali will decide to open a distribution center and expects an opportunity
ALTERNATIVE (SUMMARIZED)
MINIMAX TABLE
MANAGER CALI DECISION CRITERION : MINIMAX
TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE AVERAGE UNFAVOURABLE
Construct a Plant 80,000 -10,000 -50,000
Open a Distribution Center 40,000 20,000 -30,000
Do Nothing 0 0 0
Maximum Payoff 80,000 20,000 0
OPPORTUNITY LOSS MAXIMUM
Construct a Plant 0 30,000 50,000 50,000
Open a Distribution Center 40,000 0 0 40,000
Do Nothing 80,000 20,000 0 80,000
Minimum 40,000
DECISION: OPEN A DISTRIBUTION CENTER
 CONCLUSION TO THE

PROBLEM

1. The first manager, Unah, as an optimistic person and applying the

MAXIMAX criterion will decide to construct a plant for she is expecting a
payoff of P80,000.
2. The second manager, Yana, who is conservative or pessimistic is using the
MAXIMIN criterion will do nothing and expect no payoff.
3. The third manager, Janina, is neither optimistic nor pessimistic and is just a
realistic person. Thus, Janina uses the CRITERION OF REALISM and she has
set a 70% chance that the market is favorable. With this, she will decide to
construct a plant with an expected payoff of P41,000.
4. The fourth manager, Cara, who thinks that all outcomes have an equal
chance of occurring applies the LAPLACE criterion and will decide to open a
distribution center and expect a payoff of P10,000.
5. The fifth manager, Cali, is applying the MINIMAX criterion because he wants
to choose an alternative that will minimize losses. Therefore, he will decide to
open a distribution center and expects an opportunity loss of P40,000
DECISION-MAKING UNDER
CONDITIONS OF RISK
When making decision under conditions of risk,
1 data that enable one to provide probabilities
for the various states of nature are necessary.

The possible approaches that can be used to

2 solve these problems are; the expected monetary
value (EMV) approach and the minimizing
expected opportunity losses (EOL) approach.
These bits of information can be in the form of
3 past records or simply the subjective judgement
of the decision-maker. The source is not
important as long as they help shed some light
on which states of nature exist.
The following conditions should be met:
4 The payoff for each alternative is known.
There are few states of nature.
The probabilities of each state of nature are
known.
The cost of perfect information is known.

5 EMV is classified as wither EMV without perfect

information or EMV with perfect information.
 APPLICATION:

Consider the problem in the previous example. Julio Vera, the market
analyst of Nestlé was able to determine further the probability of
occurrence of each type of market. The probability of occurrence is 60%
that the market is favorable, 25% that the market is average, and 40% that
the market is unfavorable. He also found out that he can buy the
information on what will really happen to the market from JBC Market
Association for P2,000.
What should Julio Vera, the market analysts, choose? How much gain or
loss will he expert for the company? Should he buy the perfect
information? Why or why not? What will he do to minimize opportunity
cost?
TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE AVERAGE UNFAVOURABLE

Construct a Plant 80,000 -10,000 -50,000

Open A Distribution Center 40,000 20,000 -30,000

Do Nothing 0 0 0

Probability 60% 25% 40%

SOLUTION - ( EMV WITHOUT
PERFECT INFORMATION

Step 1: Find the EMV of each state of nature.

ALTERNATIVES

CONSTRUCT A EMV = .60 (80,000) + .25 ( -10,000) + .40 (-50,000)

PLANT: = 25,500

OPEN A DISTRIBUTION EMV = .60(40,O00) + .25 (20,000) + .40 (-30,000)

CENTER : = 17,000
EMV: .60 (0) + .25 (0) + .40 (0)
DO NOTHING : =0
Step 2: Identify the maximum EMV
=25, 500
Step 3: Draw the EMV table and conclude the recommendations
 EXPECTED MONETARY VALUE TABLE

TYPE OF MARKET
EXPANSION PLANT PAYOFF EMV
FAVOURABLE ( 60%) AVERAGE ( 25%) UNFAVOURABLE (40%)

CONSTRUCT A PLANT 80,000 -10,000 -50,000 25,500

OPEN A DISTRIBUTION CENTER 40,000 20,000 -30,000 17,000

DO NOTHING 0 0 0 0

MAXIMUM 25,500

DECISION: CONSTRUCT A PLANT

RECOMMENDATION: Julio Vera, the market analyst, should recommend to construct a plant with an expected gain
of P25,500.
SOLUTION - ( EMV WITH PERFECT
INFORMATION

STEP 1: Find the maximum payoff per column corresponding to the type of market.

TYPE OF MARKET
EXPANSION PLANT PAYOFF
FAVORABLE ( 60%) AVERAGE (25%) UNFAVOURABLE (40%)

Construct a Plant 80,000 -10,000 -50,000

Open a distribution Center 40,000 20,000 -30,000

Do Nothing 0 0 0
SOLUTION - ( EMV WITHOUT
PERFECT INFORMATION

STEP 2: Compute the value with perfect information.

STATE OF NATURE
FAVOURABLE:
= 48,000
AVERAGE:
=5,000
UNFAVOURABLE:
=0
STEP 3: Compute the expected value with perfect information.

This means that the expected value is P53,000 if the perfect information is purchased.
SOLUTION - ( EMV WITHOUT
PERFECT INFORMATION

STEP 4: Compute for the value of the perfect information.

27,500 is the value of the perfect information

STEP 5: Find the net gain with perfect information after deducting the cost
of perfect information.
 SOLUTION - ( EMV WITHOUT
PERFECT INFORMATION)
STEP 6: Draw the EMV table and conclude the recommendation
EXPECTED MONETARY VALUE ( EVM) TABLE
TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE (60%) AVERAGE (25%) UNFAVOURABLE ( 40%)
EMV
Construct a Plant 80,000 -10,000 -50,000 25,000
Open a distribution center 40,000 20,000 -30,000 17,000
Do Nothing 0 0 0 0
Maximum 25,000
DECISION : CONSTRUCT A PLANT
WITH PERFECT INFORMATION
Maximum Payoff 80,000 20,000 0
Probability 60% 25% 40%
48,000 5,000 0
53,000
27,500
2,000
25,500
BUY PERFECT INFORMATION? YES

RECOMMENDATION: If the perfect information is purchased from JBC Market Association, it will be beneficial to the
company since the sign of the net gain is positive.
SOLUTION – (EOL: EXPECTED
OPPORTUNITY LOSS)

STEP 1: Find the maximum payoff per column corresponding to the type of market.

TYPE OF MARKET
EXPANSION PLANT PAYOFF
FAVOURABLE (60%) AVERAGE(25%) UNFAVOURABLE(40%)

CONSTRUCT A PLANT 80,000 -10,000 -50,000

OPEN A DISTRIBUTION CENTER 40,000 20,000 -300,000

DO NOTHING 0 0 0
SOLUTION – (EOL: EXPECTED
OPPORTUNITY LOSS)

STEP 2: Compute the opportunity losses.

TYPE OF MARKET
EXPANSION PLANT PAYOFF
FAVOURABLE (60%) AVERAGE(25%) UNFAVOURABLE(40%)

CONSTRUCT A PLANT 80000-80,000=0 20,000-(-10,000)=30,000 0-(-50,000)=50,000

OPEN A DISTRIBUTION CENTER 80,000-40,000=40,000 20,000-20,000=0 0-(-30,000)=30,000

DO NOTHING 80,000-0=80,000 20,000-0 = 20,000 0-0=0

SOLUTION – (EOL: EXPECTED
OPPORTUNITY LOSS)

STEP 3: Compute the expected opportunity loss per row

ALTERNATIVES:

CONSTRUCT A PLANT

OPEN A DISTRIBUTION CENTER

DO NOTHING

STEP 4: Find the MINIMUM expected opportunity loss. 27,500

STEP 5: Draw the EOL table and conclude the recommendation.
EXPECTED OPPORTUNITY LOSS (EOL) TABLE
TYPE OF MARKET
EXPANSION PLAN PAYOFF
FAVOURABLE(60%) AVERAGE(25%) UNFAVOURABLE(40%)
Construct a Plant 80,000 -10,000 -50,000
Open a Distribution Center 40,000 20,000 -30,000
Do Nothing 0 0 0
Maximum Payoff 80,000 20,000 0
OPPORTUNITY LOSS EOL
Construct a Plant 0 30,000 50,000 27,500
Open a Distribution Center 40,000 0 0 36,000
Do Nothing 80,000 20,000 0 53,000
PROBABILITY 60% 25% 40%
Minimum 27,500
DECISION: OPEN A DISTRIBUTION CENTER
RECOMMENDATION: Julio Vera, the market analyst, will recommend to construct a plant with minimum
expected opportunity loss of P27,500.
MARGINAL ANALYSIS WITH
DISCRETE DISTRIBUTION
MARGINAL ANALYSIS DEFINITION:
decision making tool used in the examination
of the additional benefits of an activity
compared to the additional costs incurred by
that same activity.

MARGINAL ANALYSIS WITH DISCRETE

DISTRIBUTION
is used when more than a few states of
nature are involved; because handling such
problem contains a tremendous calculation.

CONDITIONS IN MARGINAL ANALYSIS WITH

DISCRETE DISTRIBUTION:

the alternative and the state of nature are

identical; and
the probabilities of occurrence of each
state of nature are also identical.
MARGINAL ANALYSIS WITH
DISCRETE DISTRIBUTION
When an additional unit of an item is
produced and ready to be sold, two outcomes
are possible, that is, the unit will or will not be
sold.

The sum of the probabilities of these two

events is 100%.
For example, if the probability of selling an
additional unit is 60%, then the probability
of not selling is 40%.
Thus, if p represents the probability of
selling and additional unit, then 1-p must be
the probability of not selling
If the additional unit is sold, an increase of
conditional profit, also called MARGINAL
PROFIT (MP), is realized as a result of profit
from the additional unit. The effect of
stocking an additional unit and not selling it
reduces the conditional profit. The amount
of reduction is referred to as the MARGINAL
LOSS (ML).
MARGINAL ANALYSIS WITH
DISCRETE DISTRIBUTION
The EXPECTED MARGINAL PROFIT from
stocking and selling an additional unit is
p(MP). The EXPECTED MARGINAL LOSS from
stocking and not selling is expressed as (1-p)
(ML).
EQUATION for STOCKING POINT OF UNITS:

Therefore, if (P)(MP) > (1-P)(ML) , additional units

should be stocked or produced because the
expected profit from making such a decision is
greater than the expected loss.
EQUATION for PROBABILITY OF OPTIMAL STOCKING:

Wherein:
MP = selling price per unit – cost per unit
ML = selling price per unit - MP
 ILLUSTRATION

The manager of Vogue Magazine, Jiovanni, was asked to determine

the number of magazine copies to be published every month to maximize
profit. The previous records indicate the number of copies sold for each
month. Each copy costs P6.00 to print and can be sold at P15.00. Copies
that are not sold within the month are brought to the recycling section.
How much copies should be printed each month? The probabilities of
selling copies are as follows:
a. 5% probability that 11,000 copies will be sold,
b. 6% probability that 12,000 copies will be sold,
c. 7% probability that 13,000 copies will be sold,
d. 7% probability that 14,000 copies will be sold,
e. 10% probability that 15,000 copies will be sold,
f. 15% probability that 16,000 copies will be sold,
g. 20% probability that 17,000 copies will be sold,
h. 15% probability that 18,000 copies will be sold
i. 10% probability that 19,000 copies will be sold, and
j. 5% probability that 20,000 copies will be sold
TABLE OF PROBABILITY
DISTRIBUTION

Cost per unit ( in pesos) 6

Selling Price (SP) per copy, (in pesos) 15
Sold copies per month (in thousand) Probability
11 5% = 0.05
12 6% = 0.06
13 7% = 0.07
14 7% = 0.07
15 10% = 0.10
16 15% = 0.15
17 20% = 0.20
18 15% = 0.15
19 10% = 0.10
20 5% = 0.05
STEP 1: COMPUTE THE MARGINAL
PROFIT AND MARGINAL LOSS

MP = selling price per unit – cost per unit

= 15 - 6

= 9

ML = selling price per unit – MP

= 15 – 9

= 6
STEP 2: COMPUTE THE PROBABILITY
OF OPTIMAL STOCKING.
STEP 3 : COMPUTE THE CUMULATIVE PROBABILITY.

COPIES TO BE SOLD PROBABILITY CUMULATIVE PROBABILITY

11,000 5% = 0.05 1.00-0.00=1.00
12,000 6% = 0.06 1.00-0.05=0.95
13,000 7% = 0.07 0.95-0.06=0.89
14,000 7% = 0.07 0.89-0.07=0.82
15,000 10% = 0.10 0.82-0.07=0.75
16,000 15% = 0.15 0.75-0.10=0.65
17,000 20% = 0.20 0.65-0.15=0.50
18,000 15% = 0.15 0.50-0.20=0.30
19,000 10% = 0.10 0.30-0.15=0.15
20,000 5% = 0.05 0.15-0.10=0.05
STEP 4: FIND THE MINIMUM
PROBABILITY THAT THE UNIT SOLD IS
GREATER THAN OR EQUAL TO THE
PROBABILITY OF OPTIMAL STOCK.

RECOMMENDATION: The number of copies that should be

printed every month is 17,000 copies.
 1.4.3 MARGINAL ANALYSIS WITH

NORMAL DISTRIBUTION

This model is used when there are INFINITELY MANY alternatives and
states of nature.
To use this decision-making method, the following CONDITIONS must first
be satisfied:
The selling price and marginal loss per unit are known;
The mean value and the standard deviation are identified;
And the probability distribution is normal.
ILLUSTRATION:
The storage manager of 1D Siopao Center is asked to determine the
number of siopao to be steamed per day to maximize the profit. The past
records of average sales per day were retrieved and the standard
deviation was computed. A dozen of siopao costs P36.00 and can be sold
at P96.00. Pieces of siopao not sold within the day are donated to the
Amity Charity to feed the homeless. The average sale per day is 200
dozen and the standard deviation is 20. how many dozens of siopao
should be steamed per day?
 The data are summarized below:

▪ Marginal cost per dozen P36.00

▪ Selling price per dozen P96.00

▪ Average sale per day (μ) 200

▪ Standard deviation of sales ( σ 20

STEP 1: Compute the marginal profit and marginal loss.

MP = selling price per unit – cost per unit

= 96 -36

= 60

ML = selling price per unit – MP

= 96 – 60

= 36

STEP 2: Compute the probability of optimal

stocking.
STEP 3: Compute the area under normal curve

STEP 4: Find the Z value using the table on the

areas under normal curve in the Appendix.
MP ≥ ML at Z is 0.62 =0.31

STEP 5: Compute the optimal stock.

RECOMMENDATION: The company should steam 206

dozen of siopao per day to maximize profit.
 The data are summarized below:

▪Marginal cost per dozen P60.00

▪Selling price per dozen P96.00

▪ Average sale per day (μ) 200

▪Standard deviation of sales ( σ) 20

STEP 1: MP = 36, ML = 60

STEP 2: p(S*) = 0.63

STEP 3: Area = 0.37

STEP 4: Zvalue = -0.33

STEP 5: S* = 193

RECOMMENDATION: The company should steam 193

dozen of siopao per day to maximize profit.
 THE DECISION TREE ANALYSIS

The decision process is simply the selection of a single choice among

all available alternatives. Thus, DECISION TREE is one of the most
helpful ways in making a decision.
A DECISION TREE
contains probabilities and conditional monetary values of outcomes
such that expected values can be computed.
is a physical representation of a situation.
provides a view of the total process and thereby helps decision-
makers examine possible outcomes.

ILLUSTRATION:
A construction manager has to decide whether to prepare a bid or not. It
costs P10,000 to prepare the bid. If the bid is submitted, the probability
of contract awarding is 50%. If the company awarded the contract, it may
earn an income of P200,000 if it succeeds or pay a fine of P18,000 if it
fails. The probability of success is 80%. Should the engineer prepare the
bid?
THE DECISION TREE ANALYSIS
P 200,000 -P10,000
A CIRCULAR NODE
REPRESENTS A
CHANCE OF EVENT
OR EXPECTED
VALUE
-P 18,000 -P10,000
P146,400

-P10,000
P68,000

P0
 MANAGEMENT SCIENCE

THANK YOU
FOR YOUR ATTENTION

AND PARTICIPATION
 CONGRATULATIONS!

SENATOR KIKO PANGILINAN

& SENATOR BAM AQUINO