PROBLEM 1

Step 1
path to
terminal node 9 - we have no
insurance
policy but suffer no theft. Total
profit = 0
path to
terminal node 10 - we have no
insurance policy
but suffer a theft resulting in a
loss of 10% of the
contents.
Total cost = 0.1(20000) =
2000 Total profit = - 2000
Similarly for terminal nodes 11
and 12 total profit = -4000 and -8000
respectively.
path to terminal node 13 - we have an insurance policy with company A costing 150 but suffer
no theft.
Total cost = 150 Total profit = -150
path to terminal node 14 - we have an insurance policy with company A costing 150 but suffer a
theft resulting in a loss of 0.1(20000) = 2000 for which we are reimbursed in full by company A.
Hence
Total revenue = 2000 Total cost = 2000 + 150 Total profit = -150
It is clear from this calculation that when the reimbursement equals the amount lost the total
profit will always be just the cost of the insurance.
This will be the case for terminal nodes 15 and 16 respectively.
Continuing in a similar manner we can arrive at the table below indicating for each branch the
total profit involved in that branch from the initial node to the terminal node.
Terminal node Total profit
9
0
10
-2000
11
-4000
12
-8000
13
-150
14
-150
15
-150
16
-150
17
-100
18
-100-x (x <= 2000)
19
-100-x
20
-100-x
21
-75
22
-75-2000(1-y/100)
23
-75-4000(1-y/100)
24
-75-8000(1-y/100)

We can now carry out the second step of the decision tree solution procedure where we work
from the right-hand side of the diagram back to the left-hand side.
Step 2
Consider chance node 5 with branches to terminal nodes 10, 11 and 12 emanating from it. The
expected monetary value for this chance node is given by
0.5(-2000) + 0.35(-4000) + 0.15(-8000) = -3600
Hence the EMV for chance node 1 is given by 0.97(0) + 0.03(-3600) = -108
Similarly the EMV for chance node 2 is -150.
The EMV for chance node 3 is 0.97(-100) + 0.03[0.5(-100-x) + 0.35(-100-x) + 0.15(-100-x)]
= -97 + 0.03(-100-x) = -100 - 0.03x (x <= 2000) = -101.5 since x = 50
The EMV for chance node 4 is
0.97(-75) + 0.03[0.5(-75-2000(1-y/100)) + 0.35(-75-4000(1-y/100)) + 0.15(-75- 8000(1-y/100))]
= 0.97(-75) + 0.03[-75-(1-y/100)(3600)] = -75 + 1.08y - 108 = -183 + 1.08y
= -139.8 since y = 40
Hence at the initial decision node we have the four alternatives
no policy EMV = -108
company A policy EMV = -150
company B policy EMV = -101.5
company C policy EMV = -139.8
Hence the best alternative is the policy from company B leading to an EMV of - 101.5
PROBLEM 2
Step 1
path to terminal
C1 only at a
Total
Total
Total
path
to
120K
Total

price
Total
Total
Total
path to
tender
are
Total

node 12 - we decide to tender for

price of 120K and are successful
revenue = 120
cost = 50 + 18 + 2 = 70
profit = 50 (all figures in K)
to terminal node 13 - we decide
tender for C1 only at a price of
but are unsuccessful
revenue = 0
Total cost = 50 + 2 = 52
Total profit = -52
path to terminal node 14 - we
decide to tender for C1 only at a
of 110K and are successful
revenue = 110
cost = 50 + 18 + 2 = 70
profit = 40
terminal node 15 - we decide to
for C1 only at a price of 110K but
unsuccessful
revenue = 0

Total cost
= 50 + 2 = 52
Total profit
= -52
path to terminal node 16 - we decide to tender for C2 only at a price of 70K and are successful
Total revenue = 70
Total cost = 24 + 12 + 2 = 38
Total profit = 32
path to terminal node 17 - we decide to tender for C2 only at a price of 70K but are unsuccessful
Total revenue = 0
Total cost = 24 + 2 = 26
Total profit = -26

path to terminal node 18 - we decide to tender for C2 only at a price of 65K and are successful
Total revenue = 65
Total cost = 24 + 12 + 2 = 38
Total profit = 27
path to terminal node 19 - we decide to tender for C2 only at a price of 65K but are unsuccessful
Total revenue = 0
Total cost = 24 + 2 = 26
Total profit = -26
path to terminal node 20 - we decide to tender for C2 only at a price of 60K and are successful
Total revenue = 60
Total cost = 24 + 12 + 2 = 38
Total profit = 22
path to terminal node 21 - we decide to tender for C2 only at a price of 60K but are unsuccessful
Total revenue = 0
Total cost = 24 + 2 = 26
Total profit = -26
path to terminal node 22 - we decide to tender for C1/C2 at a price of 190K and are successful
Total revenue = 190
Total cost = 50 + 18 + 10 + 3 = 81
Total profit = 109
path to terminal node 23 - we decide to tender for C1/C2 at a price of 190K but are unsuccessful
Total revenue = 0
Total cost = 50 + 3 = 53
Total profit = -53
path to terminal node 24 - we decide to tender for C1/C2 at a price of 140K and are successful
Total revenue = 140
Total cost = 50 + 18 + 10 + 3 = 81
Total profit = 59
path to terminal node 25 - we decide to tender for C1/C2 at a price of 140K but are unsuccessful
Total revenue = 0
Total cost = 50 + 3 = 53
Total profit = -53
path to terminal node 26 - we decide to tender for C1/C2 at a price of 100K and are successful
Total revenue = 100
Total cost = 50 + 18 + 10 + 3 = 81
Total profit = 19
path to terminal node 27 - we decide to tender for C1/C2 at a price of 100K but are unsuccessful
Total revenue = 0
Total cost = 50 + 3 = 53
Total profit = -53
path to terminal node 28 - we decide not to tender at all
Total revenue = 0
Total cost = 0
Total profit = 0
Hence we can form the table below indicating for each branch the total profit involved in that
branch from the initial node to the terminal node.
Terminal node
Total profit (K)
12
13
14
15
16
17
18
19
20
21

50
-52
40
-52
32
-26
27
-26
22
-26

22
23
24
25
26
27
28

109
-53
59
-53
19
-53
0

We can now carry out the second step of the decision tree solution procedure where we work
from the right-hand side of the diagram back to the left-hand side.
Step 2
Consider chance node 1 (with branches to terminal nodes 12 and 13 emanating from it). The
expected monetary value (EMV) for this chance node is given by 0.3 x (50) + 0.7 x (-52) = -21.4
Consider chance node 2, the EMV for this chance node is given by 0.85 x (40) + 0.15 x (-52) =
26.2
Then for the decision node relating to the price for C1 we have the two alternatives:
(5) price 120K EMV = -21.4
(6) price 110K EMV = 26.2
It is clear that, in terms, alternative 6 is the most attractive alternative and so we can discard
the other alternative.
Continuing the process the EMV for chance node 3 is given by 0.10 x (32) + 0.9 x (-26) = -20.2
The EMV for chance node 4 is given by 0.60 x (27) + 0.40 x (-26) = 5.8
The EMV for chance node 5 is given by 0.90 x (22) + 0.10 x (-26) = 17.2
Hence for the decision node relating to the price for C2 we have the three alternatives:
(7) price 70K EMV = -20.2
(8) price 65K EMV = 5.8
(9) price 60K EMV = 17.2
It is clear that, in terms, alternative 9 is the most attractive alternative and so we can discard
the other two alternatives.
Continuing the process the EMV for chance node 6 is given by 0.05 x (109) + 0.95 x (-53) = -44.9
The EMV for chance node 7 is given by 0.65 x (59) + 0.35 x (-53) = 19.8
The EMV for chance node 8 is given by 0.95 x (19) + 0.05 x (-53) = 15.4
Hence for the decision node relating to the price to charge for C1 and C2 we have the three
alternatives:
(10) price 190K EMV = -44.9
(11) price 140K EMV = 19.8
(12) price 100K EMV = 15.4
It is clear that, in terms, alternative 11 is the most attractive alternative and so we can discard
the other two alternatives.
Hence for the decision node relating to the tender decision we have the four alternatives:
(1) C1 only EMV = 26.2
(2) C2 only EMV = 17.2
(3) C1 and C2 EMV = 19.8
(4) no tender EMV = 0
It is clear that, in terms, alternative 1 is the most attractive alternative and so we can discard
the other three alternatives.
Hence we recommend that the company tenders for contract C1 only, with a tender price of
110K because this alternative has the highest EMV of 26.2K.
If the company follows this recommendation the actual outcome will be one of the terminal
nodes 14 or 15 (depending upon chance events) i.e. the outcome will be one of [40, -52]. Hence
the downside is that the company may lose 52K (if their tender is unsuccessful).
PROBLEM 3

Step 1
path to terminal node 8, abandon the project - profit zero
path to terminal node 9, we purchase (cost 3m), explore (cost 1m) and find manganese
(revenue 30m), total profit 26 (m)
path to terminal node 10, we purchase (cost 3m), explore (cost 1m) and find gold (revenue
250m), total profit 246 (m)
path to terminal node 11, we purchase (cost 3m), explore (cost 1m) and find silver (revenue
150m), total profit 146 (m)
path to terminal node 12, we purchase (cost 3m), explore (cost 1m) and find nothing, total
profit -4 (m)
path to terminal node 13, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an enhanced chance of significant metal deposits, purchase and explore (cost 4m) and find
manganese (revenue 30m), total profit 25 (m)
path to terminal node 14, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an enhanced chance of significant metal deposits, purchase and explore (cost 4m) and find gold
(revenue 250m), total profit 245 (m)
path to terminal node 15, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an enhanced chance of significant metal deposits, purchase and explore (cost 4m) and find
silver (revenue 150m), total profit 145 (m)
path to terminal node 16, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an enhanced chance of significant metal deposits, purchase and explore (cost 4m) and find
nothing, total profit -5 (m)
path to terminal node 17, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an enhanced chance of significant metal deposits, decide to abandon, total profit -1 (m)

path to terminal node 18, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an reduced chance of significant metal deposits, purchase and explore (cost 4m) and find
manganese (revenue 30m), total profit 25 (m)
path to terminal node 19, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an reduced chance of significant metal deposits, purchase and explore (cost 4m) and find gold
(revenue 250m), total profit 245 (m)
path to terminal node 20, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an reduced chance of significant metal deposits, purchase and explore (cost 4m) and find silver
(revenue 150m), total profit 145 (m)
path to terminal node 21, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an reduced chance of significant metal deposits, purchase and explore (cost 4m) and find
nothing, total profit -5 (m)
path to terminal node 22, we conduct the three-day test (cost 0.75m + 0.25m), find we have
an reduced chance of significant metal deposits, decide to abandon, total profit -1 (m)
Hence we can arrive at the table below indicating for each branch the total profit involved in that
branch from the initial node to the terminal node.
Terminal node Total profit
8
0
9
26
10
246
11
146
12
-4
13
25
14
245
15
145
16
-5
17
-1
18
25
19
245
20
145
21
-5
22
-1
We can now carry out the second step of the decision tree solution procedure where we work
from the right-hand side of the diagram back to the left-hand side.
Step 2
Consider chance node 7 with branches to terminal nodes 15-21 emanating from it. The expected
monetary value for this chance node is given by
0.0075(25) + 0.0004(245) + 0.00175(145) + 0.99035(-5) = -4.4125
Hence the best decision at decision node 5 is to abandon (EMV=-1).
The EMV for chance node 6 is given by 0.03(25) + 0.02(245) + 0.01(145) + 0.94(-5) = 2.4
Hence the best decision at decision node 4 is to purchase (EMV=2.4).
The EMV for chance node 3 is given by 0.5(2.4) + 0.5(-1) = 0.7
The EMV for chance node 2 is given by 0.01(26) + 0.0005(246) + 0.002(146) + 0.9875(-4) =
-3.275

Hence at decision node 1 have three alternatives:

abandon EMV=0
purchase and explore EMV=-3.275
3-day test EMV=0.7
Hence the best decision is the 3-day test as it has the highest expected monetary value of 0.7
(m).
Sharing the costs and revenues on a 50:50 basis merely halves all the monetary figures in the
above calculations and so the optimal EMV decision is exactly as before. However in a wider
context by accepting to share costs and revenues the company is spreading its risk and from that
point of view may well be a wise offer to accept