Christian Lloyd C.

Tampus
BSA 2a
MAS 201 – Management Science

Topic: Decision Analysis

1. The following payoff table shows profit for a decision analysis problem with two decision
alternatives and three states of nature:
State of Nature
Decision Alternative S₁ S₂ S₃
d₁ 250 100 25
d₂ 100 100 75

a. Construct a decision tree for this problem.

250
Decision
100
1
25

Decision
Tree

100
Decision
100
2
75

b. If the decision maker knows nothing about the probabilities of the three states of nature, what
is the recommended decision using the optimistic, conservative, and minimax regret
approaches?

Decision Maximum Profit Minimum Profit

1 250 25
2 100 75

Maximax - Optimistic approach: Decision 1

Maximin - Conservative Approach: Decision 2

Regret or opportunity loss table:

Regret = Opportunity loss
Regret = Best Pay off – Pay off received
State of Nature 1 State of Nature 2 State of Nature 3
Decision 1 0 0 50
Decision 2 150 0 0

Minimax Regret:
Decision 1 – 50
Decision 2 – 150
Must Select: Decision 1
 2. Berdan Corporation’s decision to produce a new line of recreational products 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 low, medium, or high. The following payoff
table shows the projected profit in millions of dollars:
Long-Run Demand
Plant Size Low Medium High
Small 150 200 200
Large 50 200 500
a. What is the best decision to be made, and what is the chance event for Berdan’s problem?

Answer:
A choice needs to make on whether the plant should be big or small. The result of each of these
choices will depend on the demand. There are 3 situations that might occur for each of these choices, and
it is not possible to determine exactly which situation will occur.

b. Construct an influence diagram.

Demand
States of nature
Low
Medium
High

Plant Size Profit

Consequence:
Decision Alternatives: Profit
Small
Large

c. Construct a decision tree.

150
 SMALL
200

200

Decision
Tree

50
LARGE
200

500

Note: In the decision tree, the long run demand boxes are in sequence of Low, medium, and High order.

d. Recommend a decision based on the use of the optimistic, conservative, and minimax regret
approaches.

Decision Maximum Profit Minimum Profit

SMALL 200 150
LARGE 500 50

Maximax - Optimistic approach: Decision 2 (large)

Maximin - Conservative Approach: Decision 1 (small)

Regret or opportunity loss table:

Regret = Opportunity loss
Regret = Best Pay off – Pay off received
Low Medium High
Small 0 0 300
Large 100 0 0

Minimax Regret:
Small – 300
Large – 100
Must Select: Large`(D2)

3. Jan Hayudini is interested in leasing a new Honda and has contacted three automobile dealers for
pricing information. Each dealer offered Jan a closed-end 26-month lease with no down payment
due at the time of signing. Each elase includes a monthly charge and a mileage allowance.
Additional miles receive a surcharge on a per-mile basis. The monthly lease cost, the mileage
allowance, and the cost for additional miles follow:

Cost per add.

Dealer Monthly Cost Mileage Allowance Mile
Hepburn Honda $299 36,000 $0.15
Midtown Motors 310 45,000 0.20
Hopkins Automotive 325 54,000 0.15

Jan decided to choose the lease option that will minimize her total 36-month cost. The difficulty is that
Jan is not sure how many miles he will drive over the next three years. For purposes of this decision, he
believes it is reasonable to assume that he will drive 12,000 miles per year, 15,000 miles per year, or
18,000 miles per year. With this assumption, Jan estimated his total costs for the three lease options. For
example, he figures that the Hepburn Honda lease will cost her $10,764 is she drive 12,000 miles per
year, $12,114 if she drives 15,000 per year, or $13,464 If she drives 18,000 miles per year.
a. What is the decision, and what is the chance event?
Answer:
 The decision is to select the best lease option from three alternatives (Hepburn
Honda, Midtown Motors, and Hopkins Automotive) and the chance event is the
monthly cost that Amy will incur.

b. Construct a payoff table for Jan’s problem.

Miles Driven Per Year
Alternatives 12,000 15,000 18,000
Hepburn Honda 10,764 12,114 13,464
Midtown Motors 11,160 11,160 12,960
Hopkins Automotive 11,700 11,700 11,700

c. If Jan has no idea which of the three mileage assumptions is most appropriate, what is the
recommended decision (leasing option) using the optimistic, conservative, and minimax regret
approaches?

Decision Max cost Min cost

Hepburn Honda 13,464 10,764
Midtown Motors 12,960 11,160
Hopkins Automotive 11,700 11,700

Maximax - Optimistic approach: Decision: Hopkins Automotive

Maximin - Conservative Approach: Decision: Hepburn Honda
Regret or opportunity loss table:
Regret = Opportunity loss
Regret = Best Pay off – Pay off received
Alternatives Miles Driven Per Year
12,000 15,000 18,000
Hepburn Honda 936 0 0
Midtown Motors 540 954 504
Hopkins Automotive 0 414 1,764

Minimax Regret:
Hepburn Honda - 936
Midtown Motors – 1,998
Hopkins Automotive – 2,178
Must Select: Hepburn Honda

d. Suppose that the probabilities that Jan drives 12,000, 15,000, and 18,000 miles per year are 0.5,
0.4, and 0.1, respectively. What option should Jan choose using the expected value approach?

Miles Driven Per Year

Alternatives 12,000 15,000 18,000
Hepburn Honda 10,764 12,114 13,464
Midtown Motors 11,160 11,160 12,960
Hopkins Automotive 11,700 11,700 11,700

N
EV (Hepburn Honda) = ∑ P ( Sj ) V i j
j=1
= 0.5 (10,764) + 0.4 (12,114) + 0.1 (13,464)
= 5,382 + 4,845.6 + 1,346
= 11,573.6
N
EV (Midtown Motors) = ∑ P ( Sj ) V i j
j=1
= 0.5 (11,160) + 0.4 (11,160) + 0.1 (12,960)
= 5,580 + 4,464 + 1,296
= 11,340

N
EV (Hopkins Automotive) = ∑ P ( Sj ) V i j
j=1
= 0.5 (11,700) + 0.4 (11,700) + 0.1 (11,700)
= 5,850 + 4,680 + 1,170
= 11,700

EV Midtown Motors has lesser cost than EV Hopkins Automotive and EV Hepburn Honda, which
therefore implies that the optimal decision among alternatives is Midtown Motors

e. Develop a risk profile for the decision selected in part (d). What is the most likely cost, and what
is its probability?
 Hopkins Automoti ve's Risk Profi le
Column2
13,000

12,500

12,000

11,500

11,000

10,500

10,000

9,500

9,000
0.4 0.6 0.8 1

The most likely cost is $11,160 with a probability of 0.9.

There is a probability of 0.1 of incurring a cost of $12,960.

f. Suppose that after further consideration, Jan concludes that the probabilities that he will drive
12,000, 15,000, and 18,000 miles per year are 0.3, 0.4, and 0.3, respectively. What decision
should Jan make using the expected value approach?

Miles Driven Per Year

Alternatives 12,000 15,000 18,000
Hepburn Honda 10,764 12,114 13,464
Midtown Motors 11,160 11,160 12,960
Hopkins Automotive 11,700 11,700 11,700

N
EV (Hepburn Honda) = ∑ P ( Sj ) V 1 j
j=1
= 0.3 (10,764) + 0.4 (12,114) + 0.3 (13,464)
= 3,229.2 + 4,845.6 + 4,039.2
= 12,114
N
EV (Midtown Motors) = ∑ P ( Sj ) V 1 j
j=1
= 0.3 (11,160) + 0.4 (11,160) + 0.3 (12,960)
= 3,348 + 4,464 + 3,888
= 11,700

N
EV (Hopkins Automotive) = ∑ P ( Sj ) V 1 j
j=1
 = 0.3 (11,700) + 0.4 (11,700) + 0.3 (11,700)
= 3,510 + 4,680 + 3,510
= 11,700

EV Midtown Motors and EV Hopkins Automotive has lower cost that EV Hepburn, which therefore
implies that the optimal decision among alternatives is either EV Midtown Motors or EV Hopkins
Automotive.

4. The following profit payoff table was presented in Problem 1. Suppose that the decision maker
obtained the probability assessments P(S₁) = 0.65, P(S₂) = 0.15, P(S₃) = 0.20. Use the expected
value approach to determine the optimal decision.
State of Nature
Decision Alternative S₁ S₂ S₃
d₁ 250 100 25
d₂ 100 100 75

Sate of nature
Decision Alternative S1 S2 S3
Decision 1 250 100 25
Decision 2 100 100 75

P(S2) = 0.65
P(S2) = 0.15
P(S3) = 0.2

Expected value (EV) is the sum of the products of the probabilities and the corresponding payoffs.

N
EV (D1) = ∑ P ( Sj ) V 1 j
j=1
= 0.65 (250) + 0.15 (100) + 0.2 (25)
= 182.5
N
EV (D2) = ∑ P ( Sj ) V 2 j
j=1
= 0.65 (100) + 0.15 (100) + 0.2 (75)
= 95
EV 1 is higher than EV 2, which therefore implies that the optimal decision between D1 and D2 is D1