Narsee Monjee Institute of Management Studies

Decision Analysis and Modeling MBA Core : 2015-16 Trimester II

Title: Decision Theory: Uncertainty

1. Consider a problem where we have three strategies S1, S2, and S3 and the states of nature are N1, N2
and N3. The pay off for each combination are known or estimated.
N1 N2 N3 (State of nature )
Strategy↓ S1 15 12 18
S2 9 14 10
S3 13 4 26
Make the decisions under The maximax Maximin Hurwitz Use an  value of 0.9., Laplace and
Minimax Regret criteria.
Laplac hurwit
St of nature-> N1 N2 N3 Max Min e z
Strateg
y 0.9
S1 15 12 18 18 12 15 17.4
S2 9 14 10 14 9 11 13.5
14.333
S3 13 4 26 26 4 3 23.8
Maxima
x 26 12 15 23.8
Minima
x 14 4 S3
Regret N1 N2 N3
Strateg
y
S1 0 2 8 8
S2 6 0 16 16
S3 2 10 0 10
Maxima
x 16
Minima
x 8

2. You are given the following payoffs of three acts A1,A2,A3 and the states of nature S1,S2,S3:
States of nature↓ Acts→ A1 A2 A3
S1 25 -10 -125
S2 400 440 400
S3 650 740 750
Make the decisions under The maximax Maximin Hurwitz Use an  value of 0.6. and Laplace criteria.
Laplac
St of nature-> s1 s2 s3 Max Min EMV e
Strateg
y 0.1 0.7 0.2
A1 25 400 650 650 25 412.5 358.33
A2 -10 450 740 740 -10 462 393.33
A3 -125 400 750 750 -125 417.5 341.67
750 25 462 393.33
A3 A1 A2 A2

3. . Given the following pay off in Rs. Matrix:

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 State of nature Probability Decision
Don’t expand expand 200 units Expand 400 units
High demand 0.4 2500 3500 5000
Medium demand 0.4 2500 3500 2500
Low demand 0.2 2500 1500 1000
What should be the decision if we use (i) Emv criterion,(ii) The Minimax criterion (iii) The maximin
criterion?
Probabilit
State of nature y Decision
Don’t expand 200
expand units Expand 400 units
High demand 0.4 2500 3500 5000 Max
Medium demand 0.4 2500 3500 2500
Low demand 0.2 2500 1500 1000
320 Expand 400
EMV 2500 3100 3200 0 units
500 Expand 400
Maxi 2500 3500 5000 0 units
250
Min 2500 1500 1000 0 Don’t expand

4 . Suppose that a decision maker faced with four decision alternatives and four states of nature
develops the following profit payoff table.
Decision Alternative↓State of Nature→ S1 S2 S3 S4
d1 14 9 10 5
d2 11 10 8 7
d3 9 10 10 11
d4 8 10 11 13
a. If the decision maker knows nothing about the probabilities of the states of nature, what
is the recommended decision using the optimistic, conservative, and minimax regret approaches?
b. Which approach do you prefer? Explain. Is establishing the most appropriate approach
before analysing the problem important for the decision maker? Explain.
c. Assume that the payoff table provides cost rather than profit payoffs. What is the
recommended decision using the optimistic, conservative, and minimax regret approaches?
Decision
Alternative↓ S1 S2 S3 S4 Max Min

d1 14 9 10 5 14 5
d2 11 10 8 7 11 7
d3 9 10 10 11 11 9
d4 8 10 11 13 13 8
Max 14 9

Regret d1 d3
Decision
Alternative↓ S1 S2 S3 S4 Max
d1 0 1 1 8 8
d2 3 0 3 6 6
d3 5 0 1 2 5
d4 6 0 0 0 6
Min 5
5 d3

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 Cost Table:

Decision Alternative↓ S1 S2 S3 S4 Min Max

d1 14 9 10 5 5 14
d2 11 10 8 7 7 11
d3 9 10 10 11 9 11
d4 8 10 11 13 8 13
Min 5 11

Opportunity Loss
Table:

Decision Alternative↓ S1 S2 S3 S4 Max

d1 6 0 2 0 6
d2 3 1 0 2 3
d3 1 1 2 6 6
d4 0 1 3 8 8
Min 3

5. Southland Corporation’s decision to produce a new line of recreational products has resulted in the
need to construct either a small plant or a large plant,. The best selection of plant size depends on how
the marketplace reacts to the new product line. To conduct an analysis, marketing management has
decided to view the possible long-run demand as either low, medium, or high. The following payoff
table shows the projected profit in millions of dollars:
Plant Size↓ Long-Run Demand→Low Medium High
Small 150 200 200
Large 50 200 500
a. What is the decision to be made, and what is the chance event for Southland’s problem?
b. Construct a decision tree.
c. Recommend a decision based on the use of the optimistic, conservative, and minimax
regret approaches.

Long-Run
Demand Mediu
Plant Size↓ → Low m High max min
Small 150 200 200 200 150
Large 50 200 500 500 50
Max 500 150
Smal
6 Large l
Opportini
ty Loss
3
 Table:
Plant Mediu
Size Demand Low m High Max
Small 0 0 300 300
Large 100 0 0 100
Min 100

6. Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job,
Ken has been able to increase his annual salary by a factor of over 100. At the present time, ken is
forced to consider purchasing some more equipment for Brown Oil because of competition. His
alternatives are shown in the following table.
EQUIPMENT FAVORABLE MARKET ($) UNFAVORABLE MARKET ($)
Sub 100 300,000 - 200,000
Oiler J 250,000 - 100,000
Texan 75,000 - 18,000
For example, if Ken purchases a Sub 100 and if there is a favourable market, he will suffer a loss of $
200,000. But Ken has always been a very optimistic decision maker.
(a) What type of decision is Ken facing?
(b) What decision criterion should he use?
(c) What alternative is best

FAVORABLE UNFAVORABLE
EQUIPMENT MARKET ($) MARKET ($) Max Min
Sub 100 3,00,000 -200,000 300,000 -200,000
Oiler J 2,50,000 -100,000 250,000 -100,000
Texan 75,000 -18,000 75,000 -18,000

Max 300,000 -18,000

7. Today’s Electronics specializes in manufacturing modern electronic components. It also builds the
equipment that produces the components. Phyllis Weinberger, who is responsible for advising the
president of Today’s Electronics on electronic manufacturing equipment, has developed the following
table concerning a proposed facility:
PROFIT ($)

STRONG MARKETFAIR MARKET POOR MARKET

Large facility 550,000 110,000 -310,000
Medium-sized facility 300,000 129,000 -100,000
Small facility 200,000 100,000 - 32,000
No facility 0 0 0
(a) Develop an opportunity loss table.
(b) What is the minimax decision?
Alternatives A1 A2 A3 A4
Sr no States of nature
55000 20000
1 S1 0 300000 0 0
11000 10000
2 S2 0 129000 0 0
3 S3 - -100000 -32000 0 Maximu
4
 31000
0 m
55000 20000
Maximum 0 300000 0 0 550000
MaxiMax A1
-
31000
Minimum 0 -100000 -32000 0 0
Alpha MaxiMin A4
12000
0.5 Hurwitz 0 100000 84000 0 120000
Hurwitz A1
11666 109666. 89333.
Laplace 7 7 3 0 116667
Laplace A1

Regret
Table

Alternative
s A1 A2 A3 A4
States of nature
S1 0 250,000 350,000 550,000
S2 19,000 0 29,000 129,000
S3 310,000 100,000 32,000 0 min
350,00 550,00 250,00
Max 310,000 250,000 0 0 0
A2

8. Even though independent gasoline stations have been having a difficult time, Susan Solomon has
been thinking about starting her own independent gasoline station. Susan’s problem is to decide how
large her station should be. The annual returns will depend on both the size of her station and a
number of marketing factors related to the oil industry and demand for gasoline. After a careful
analysis. Susan developed the following table:
SIZE OF FIRST GOOD MARKET FAIR MARKET POOR MARKET
STATION ($) ($) ($)
Small 50,000 20,000 -10,000
Medium 80,000 30,000 -20,000
Large 1,00,000 30,000 - 40,000
Very large 300,000 25,000 -160,000
For example, if Susan constructs a small station and the market is good, she will realize a profit of
$50,000.
(a) Develop a decision table for this decision.
(b) What is the maximax decision?
(c) What is the maximin decision?
(d) What is the equality likely decision?
(e) What is the criterion of realism decision? Use an  value of 0.8.
(f) Develop an opportunity loss table.
(g) What is the minimax decision?
1 2 3 4
Alternatives A1 A2 A3 A4
Sr no States of nature
10000
1 S1 50000 80000 0 300000
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 2 S2 20000 30000 30000 25000
3 S3 -10000 -20000 -40000 -160000
Maximum
Maximum 50000 80000 30000 300000 300000
MaxiMax A4
Minimum -10000 -20000 -40000 -160000 -10000
Alpha MaxiMin A1
0.5 Hurwitz 20000 30000 -5000 70000 70000
Hurwitz A4
Laplace 20000 30000 -5000 55000 55000
Laplace A4

9. After buying a computer system, Sim Thomas must decide whether to purchase (1) a complete maintenance
(or service) policy at a cost of $ 500, which would cover all maintenance costs; (2) a partial maintenance policy
at a cost of $300, which would cover some of the costs of any maintenance; or (3) no maintenance policy. The
consequences, costs, and probabilities are given in the following table:
maintenance required not required
No Service Agreement $3,000 $0
Partial Service Agreement $1,500 $300
Complete Service Agreement $ 500 $ 500
Probabilities 0.2 0.8
(a) What do you recommend?
(b) If the probability of needing maintenance is 0.8 (instead of 0.2) and the probability of not needing
maintenance is 0.2, how does this change Sim’s decision?

Partial Complete
Service Service
No Service Agreeme Agreeme Probabiliti
Agreement nt nt es

Maintance
required $3,000 $1,500 $500 0.2
Maintance not
required $0 $300 $500 0.8
$600 $540 $500 $500

a. He should go in for Complete Service Agreement.

Partial Complete
Service Service
No Service Agreeme Agreeme Probabiliti
Agreement nt nt es

Maintance
required $3,000 $1,500 $500 0.8
Maintance not
required $0 $300 $500 0.2
$2,400 $1,260 $500 $500

b. It does not change Sim’s decision.

10. A multi-national company (MNC) is planning a mega-project, for which one of the three sites S1,
S2 and S3 is likely to be selected. The company may take time to decide the choice.
Natura Hotels and resorts(NHR) is planning to buy land for hotel near one or more of the sites S1,
S2 and S3. The following data has been collected.

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Site Price of land today (Present value of price of the land)(Rs. Lakhs)
if selected by MNC if not selected MNC
S1 40 90 20
S2 60 100 40
S3 50 70 40
As the land prices will increase as soon as MNC takes decision, NHR has to take decision quickly.
What would be the choice of NHR under Following?
(i) Optimistic criterion S1
(ii) Conservative criterion S3
(iii) Hervitz alpha with alpha = 0.8. S1
Payoff Table:
S1 S2 S3
Selected by MNC 50 40 20
Not Selected by
MNC -20 -20 -10
Maximax 50 40 20
Maximin -20 -20 -10
H 36 28 14

10. A toy manufacturer is considering a project of manufacturing a dancing doll with three
different movement designs. The doll will be sold at an average of Rs.10. The first movement design
using ‘gears and levers’ will provide the lowest tooling and set up cost of Rs.1,00,000 and Rs.5 per
unit of variable cost. A second design with spring action will have a fixed cost of Rs.1,60,000 and
variable cost of Rs.4 per unit. Yet another design with weights and pulleys will have a fixed cost of
Rs.2,00,000 and variable cost Rs.3 per unit.
Demand Sales
Light demand 25,000
Moderate demand 1,00,000
Heavy demand 1,50,000
i. Construct a payoff table for the above project.
ii. Based on the following criteria, find the best course of action:
a. Criterion of optimism Weights & Pulleys
b. Regret criterion Weights & Pulleys
c. Hurwicz criterion (α = .4) Weights & Pulleys
iii. If the following additional information becomes available, then which is the optimum
design? Weights & Pulleys
Demand (units) Probability
Light demand 0.1
Moderate
demand 0.7
Heavy demand 0.2
i. How much can the decision maker afford to pay for perfect information? 5000
ii. Calculate the EOL. 5000

Payoff Table
Gears & Spring Weights &
Prob Demand Levers Action Pulleys
0.1 Light demand 25000 -10000 -25000
0.7 Moderate 400000 440000 500000
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 demand
Heavy
0.2 demand 650000 740000 850000
Maximax 650000 740000 850000
Hurwicz 275000 290000 325000
EMV Criterion 412500 455000 517500
EPPI 522500
EVPI 5000
Opportunity Loss Table
Gears & Spring Weights &
Demand Levers Action Pulleys
0.1 Light demand 0 35000 50000
Moderate
0.7 demand 100000 60000 0
Heavy
0.2 demand 200000 110000 0
Minimax 200000 110000 50000
Expected Opp
Loss 110000 67500 5000