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SOLUTION TO PROBLEMS IN HW SET 8

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a) Light 0.4 12,000

14,400

Buy Heavy 0.6 16,000

Light 0.4 9,500

Lease 14,000

Heavy 0.6 17,000

b) EMV for Buy Option = 12,000 * 0.4 + 16,000 * 0.6 = 14,400. (cost)

EMV for Lease Option = 9,500 * 0.4 + 17,000 * 0.6 = 14,000 (cost)

Recommended Option: Lease.

c) Assume Perfect Information

Use is assumed to be Light. (Probability = 0.40)

Without addl.work With addl. work

Action to be taken Lease Lease
Net Cost 9,500 9,500
Opportunity Loss = 950 950 = 0.

Use is assumed to be Intense. (Probability = 0.60)

Without addl.work With addl. work

Action to be taken Lease Buy
Net Cost 17,000 16,000

Opportunity Loss = 17,000 16,000 = 1,000.

Expected Value of Perfect Information = 0 * 0.4 + 1000 * 0.6 = $ 600.00
Cost of additional work = (2000)*1/2 = $ 1000.00

Recommendation: Do not waste any more time.

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2) a) Good 2/3 3,000

4,000

Buy old Def. 1/3 6,000

Buy new 4,400

EMV for Buy New Machine Option = $ 4,400. (cost)

EMV for Buy Old Machine Option = 3,000 * (2/3) + (3000+3000) * (1/3) = $ 4,000 (cost)

Recommended Option: Buy the Old Machine.

b) For a given condition of the old machine

Good(G) (2/3) Defective (D) (1/3)

Prediction
Good (PG) 1.0 0.25
Defective(PD) 0.0 0.75

P (PG) = P( PG G) + P( PG D)
= P(PG / G) * P(G) + P(PG / D) * P(D)
= 1 * (2/3) + 0.25 * (1/3) = 0.75
P (PD) = P( PD G) + P( PD D)
= P(PD / G) * P(G) + P(PD / D) * P(D)
= 0 * (2/3) + 0.75 * (1/3) = 0.25
Joint Probabilities
Condition of the machine
Good Defective
(G) (D) Marginal
Prediction Prob.

Good (PG) 2/3 1/12 0.75

Defective (PD) 0 0.25 0.25

2/3 1/3 1.00

P(G/PG) = P( PG G)/P(PG) = (2/3)/0.75 = 0.89; P(D/PG) = 1 0.89 = 0.11

P(G/PD) = P( PD G)/P(PG) = (0)/0.25 = 0.0 ; P(D/PD) = 1 0 = 1.00

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