Decision Tree Exercises

London Pop Concert
An entertainment company is organizing a pop concert in London. The company has to decide
how much it should spend on publicizing the event and three options have been identified:
Option 1: Advertise only in the music press;

Option 2: As option 1 but also advertise in the national press;
Option 3: As options 1 and 2 but also advertise on commercial radio.
For simplicity, the demand for tickets is categorized as low, medium or high. The payoff table
below shows how the profit which the company will earn for each option depends on the level of
demand.
Demand
Option Low Medium High Profits ($000s)
1 −20 −20 100
2 −60 −20 60
3 −100 −60 20
It is estimated that if option 1 is adopted the probabilities of low, medium and high demand are
0.4, 0.5 and 0.1, respectively. For option 2 the respective probabilities are 0.1, 0.3 and 0.6 while
for option 3 they are 0.05, 0.15 and 0.8. Determine the option which will lead to the highest
expected profit. Would you have any reservations about recommending this option to the
company?
Machine Repair
A large machine in a factory has broken down and the company that owns the factory will incur
costs of $3200 for each day the machine is out of action. The factory’s engineer has three
immediate options:
Option 1
He can return the machine to the supplier who has agreed to collect, repair and return it free of
charge, but not to compensate the company for any losses they might incur while the repair is
being carried out. The supplier will not agree to repair the machine if any other person has
previously attempted to repair it. If the machine is returned, the supplier will guarantee to return it
in working order in 10 days’ time.
Option 2
He can call in a specialist local engineering company. They will charge $20 000 to carry out the
repair and they estimate that there is a 30% chance that they will be able to return the machine to
working order in 2 days. There is, however, a 70% chance that repairs will take 4 days.
Option 3
He can attempt to carry out the repair work himself, and he estimates that there is a 50% chance
that he could mend the machine in 5 days. However, if at the end of 5 days the attempted repair
has not been successful he will have to decide whether to call in the local engineering company or
to make a second attempt at repair by investigating a different part of the mechanism. This
would take 2 further days, and he estimates that there is a 25% chance that this second attempt
would be successful. If he fails at the second attempt, he will have no alternative other than to
call in the local engineering company. It can be assumed that the probability distribution for the
local engineering company’s repair time will be unaffected by any work which the factory engineer
has carried out.
Assuming that the engineer’s objective is to minimize expected costs, what course(s) of action
should he take?
Westward Magazine Publishers
Westward Magazine Publishers are thinking of launching a new fashion magazine for women in
the under-25 age group. Their original plans were to launch in April of next year, but information
has been received that a rival publisher is planning a similar magazine. Westward now have to
decide whether to bring their launch forward to January of next year, though this would cost an
additional $500 000. If the launch is brought forward it is estimated that the chances of launching
before the rival are about 80%. However, if the launch is not brought forward it is thought that
there is only a 30% chance of launching before the rival.
For simplicity, the management of Westward have assumed that the circulation of the magazine
throughout its life will be either high or low. If Westward launch before the rival, it is thought that
there is a 75% chance of a high circulation. However, if the rival launches first, this probability is
estimated to be only 50%.
If the rival does launch first then Westward could try to boost sales by increasing their level of
advertising. This would cost an extra $200 000, but it is thought that it would increase the
probability of a high circulation to 70%. This increased advertising expenditure would not be
considered if Westward’s magazine was launched first. Westward’s accountants have estimated
that a high circulation would generate a gross profit over the magazine’s lifetime of $4 million. A
low circulation would bring a gross profit of about $1 million. It is important to note, however,
that these gross profits do not take into account additional expenditure caused by bringing the
launch forward or by increased advertising.
a. Draw a decision tree to represent Westward’s problem.
b. Assuming that Westward’s objective is to maximize expected profit, determine the policy that
they should choose. (For simplicity, you should ignore Westward’s preference for money over
time: for example, the fact that they would prefer to receive a given cash inflow now rather
than in the future.)
c. In reality, Westward have little knowledge of the progress which has been made by the rival.
This means that the probabilities given above for beating the rival (if the launch is, or is not,
brought forward) are very rough estimates. How sensitive is the policy you identified in (b) to
changes in these probabilities?

Decision Tree Exercises

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London Pop Concert

Option 1: Advertise only in the music press;

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