Chap 2 Decision Analysis (Due Sept 22)

1. Even though independent gasoline stations have been having a difficult time, Susan Solomon has
been thinking about starting her own independent gasoline station. Susans 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
40,000
15,000
8,000
Medium
75,000
28,000
18,000
Large
96,000
28,000
37,000
Very large
290,000
24,000
150,000
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 equally 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 regret decision?

2. Peter Martin is going to help his brother who wants to open a food store. Peter initially believes that
there is a 5050 chance that his brothers food store would be a success. Peter is considering doing a
market research study. Based on historical data, there is a 0.82 probability that the marketing research
will be favorable given a successful food store. Moreover, there is a 0.71 probability that the
marketing research will be unfavorable given an unsuccessful food store.
(a) If the marketing research is favorable, what is Peters revised probability of a successful food
store for his brother?
(b) If the marketing research is unfavorable, what is Peters revised probability of a successful
food store for his brother?
(c) If the initial probability of a successful food store is 0.60 (instead of 0.50), find the
probabilities in parts a and b.
3. A financial advisor has recommended two possible mutual funds for investment: Fund A and Fund B.
The return that will be achieved by each of these depends on whether the economy is good, fair, or
poor. A payoff table has been constructed to illustrate this situation:

INVESTMENT
Fund A
Fund B
Probability

GOOD ECONOMY
$5,000
$3,000
0.2

FAIR ECONOMY
$1,000
$2,000
0.3

POOR ECONOMY
-$2,500
0
0.5

(a) Draw the decision tree to represent this situation.

(b) Perform the necessary calculations to determine which of the two mutual funds is better.
Which one should you choose to maximize the expected value?
(c) Suppose there is question about the return of Fund A in a good economy. It could be higher or
lower than $5,000. What value for this would cause a person to be indifferent between Fund A
and Fund B (i.e., the EMVs would be the same)?

4. Mary is considering opening a new grocery store in town. She is evaluating three sites: downtown,
the mall, and out at the busy traffic circle. Mary calculated the value of successful stores at these
locations as follows: downtown, $250,000; the mall, $300,000; the circle, $400,000. Mary calculated
the losses if unsuccessful to be $100,000 at either downtown or the mall, and $200,000 at the circle.
Mary figures her chance of success to be 50% downtown, 60% at the mall and 75% at the circle.
a. Draw a decision tree for Mary and select her best alternative.
b. Mary has been approached by a marketing research firm that offers to study the area to determine
if another grocery store is needed. The cost of this study is $30,000. Mary believes there is a 60%
chance that the survey result will be positive (show a need for another grocery store). Define SRP
= survey results positive, SRN = survey results negative, SD = success downtown, SM = success
at mall, SC = success at circle, SD = dont succeed downtown, and so on. For studies of this
nature: P(SRP| success)=0.7; P(SRP| not success)=0.2. Calculate the revised probability for
success and not success for each location, depending on survey results.
c. How much is the marketing research worth to Mary? Calculate the EVSI.

5. Explain the following two statements. Show both of the statements hold through the Thomson
Lumber Company example on page 3 of the lecture note.
a. Minimum EOL will always result in the same decision as maximum EMV
b. Minimum EOL = EVPI