Chapter 3

Quantitative Analysis for Management, 13e (Render et al.
)
Chapter 3 Decision Analysis
1) Expected monetary value (EMV) is the average or expected monetary outcome of a decision if
it can be repeated a large number of times.
Answer: TRUE
Diff: Moderate
Topic: DECISION MAKING UNDER RISK
LO: 3.4: Use probability values to make decisions under risk.
AACSB: Analytical thinking
Classification: Concept
2) Expected monetary value (EMV) is the payoff you should expect to occur when you choose a
particular alternative.
Answer: FALSE
Diff: Moderate
3) The decision maker can control states of nature.

Answer: FALSE
Diff: Easy
Topic: THE SIX STEPS IN DECISION MAKING
LO: 3.1: List the steps of the decision-making process.
4) All decisions that result in a favorable outcome are considered to be good decisions.
Answer: FALSE
Diff: Moderate
Topic: INTRODUCTION
5) The difference in decision making under uncertainty and decision making under certainty is
that under uncertainty, we think we know the probabilities of the states of nature, while under
certainty we know exactly the probabilities of the states of nature.
Answer: FALSE
Diff: Moderate
Topic: TYPES OF DECISION-MAKING ENVIRONMENTS
LO: 3.2: Describe the types of decision-making environments.
6) EVPI (expected value of perfect information) provides the decision maker a value of the
lowest amount she should be willing to pay for additional information.
Answer: FALSE
Diff: Moderate
7) EOL will always result in the same decision as the maximum EMV with revenue data, but will
pick the worst alternative with cost data.
Answer: FALSE
Diff: Moderate
8) Sensitivity analysis assumes no increasing or decreasing economies of scale.

Answer: TRUE
Diff: Moderate
9) The maximax decision criterion is used by pessimistic decision makers and maximizes the
maximum outcome for every alternative.
Answer: FALSE
Diff: Easy
Topic: DECISION MAKING UNDER UNCERTAINTY
LO: 3.3: Make decisions under uncertainty.
10) The maximin decision criterion is used by pessimistic decision makers and minimizes the
maximum outcome for every alternative.
Answer: FALSE
Diff: Moderate
11) Optimistic decision makers tend to discount favorable outcomes.
Answer: FALSE
Diff: Moderate
12) The decision theory processes of maximizing expected monetary value (EMV) and
minimizing expected opportunity loss (EOL) should lead us to choose the same alternatives.
Answer: TRUE
Diff: Moderate
13) The several criteria (maximax, maximin, equally likely, criterion of realism, minimax regret)
used for decision making under uncertainty cannot lead the choice of the same alternative.
Answer: FALSE
Diff: Moderate
14) A decision table is sometimes called a payout table.

Answer: TRUE
Diff: Moderate
15) The maximum value in a regret table constructed from a decision table populated with cost
data corresponds to the optimal alternative.
Answer: FALSE
Diff: Moderate
16) Any problem that can be presented in a decision table can also be graphically portrayed in a
decision tree.
Answer: TRUE
Diff: Moderate
Topic: DECISION TREES
LO: 3.6: Develop accurate and useful decision trees.
17) Any problem that can be represented in a decision tree can be easily portrayed in a decision
table.
Answer: FALSE
Diff: Moderate
18) The decision making criterion of realism only applies to maximizing expected payoff.
Answer: FALSE
Diff: Moderate
19) In a decision table, all of the alternatives are listed down the left side of the table, while all of
the possible outcomes or states of nature are listed across the top.
Answer: TRUE
Diff: Moderate
20) The EMV approach and Utility theory always result in the same choice of alternatives.
Answer: FALSE
Diff: Easy
Topic: UTILITY THEORY
LO: 3.8: Understand the importance and use of utility theory in decision making.
21) Utility theory may help the decision maker include the impact of qualitative factors that are
difficult to include in the EMV model.
Answer: TRUE
Diff: Easy
22) In a decision problem where we wish to use Bayes' theorem to calculate posterior
probabilities, we should always begin our analysis with the assumption that all states of nature
are equally likely, and use the sample information to revise these probabilities to more realistic
values.
Answer: FALSE
Diff: Moderate
Topic: HOW PROBABILITY VALUES ARE ESTIMATED BY BAYESIAN ANALYSIS
LO: 3.7: Revise probability estimates using Bayesian analysis.
23) A utility curve that shows utility increasing at an increasing rate as the monetary value
increases represents the utility curve of a risk seeker.
Answer: TRUE
Diff: Moderate
24) A utility curve that shows utility increasing at a decreasing rate as the monetary value
increases represents the utility curve of a risk seeker.
Answer: FALSE
Diff: Moderate
25) A decision maker is assigning equal probabilities to all states of nature in a decision making
under uncertainty situation but is uncomfortable doing so. Therefore, this is actually a decision
making under risk situation.
Answer: TRUE
Diff: Difficult
26) Utility values typically range from -1 to +1.

Answer: FALSE
Diff: Moderate
27) By studying a person's Utility Curve, one can determine whether the individual is a risk
seeker, risk avoider, or is indifferent to risk.
Answer: TRUE
Diff: Moderate
28) The Laplace criterion represents a compromise between the maximax and maximin
decisions.
Answer: FALSE
Diff: Moderate
29) Utility theory provides a decision criterion that is superior to the EMV or EOL in that it may
allow the decision maker to incorporate her own attitudes toward risk.
Answer: TRUE
Diff: Moderate
30) The assignment of a utility value of 1 to an alternative implies that the alternative is preferred
to all others.
Answer: TRUE
Diff: Moderate
31) A second table (an opportunity loss table) must be computed when applying the maximin
decision criterion.
Answer: FALSE
Diff: Moderate
32) The following figure illustrates a utility curve for someone who is a risk seeker.
Answer: TRUE
Diff: Moderate
33) An analytic and systematic approach to the study of decision making is referred to as
A) decision making under risk.
B) decision making under uncertainty.
C) decision theory.
D) decision analysis.
Answer: C
Diff: Moderate
Topic: INTRODUCTION
34) What makes the difference between good decisions and bad decisions?
A) A good decision is based on logic.
B) A good decision considers all available data.
C) A good decision considers all alternatives.
D) A good decision applies quantitative approaches.
Answer: C
Diff: Easy
Topic: INTRODUCTION
35) Expected monetary value (EMV) is

A) the average or expected monetary outcome of a decision if it can be repeated a large number
of times.
B) the average or expected value of the decision, if you know what would happen ahead of time.
C) the average or expected value of information if it were completely accurate.
D) the amount you would lose by not picking the best alternative.
Answer: A
Diff: Moderate
36) Which of the following is not considered a criterion for decision making under uncertainty?
A) optimistic
B) pessimistic
C) equally likely
D) random selection
Answer: D
Diff: Easy
37) A pessimistic decision-making criterion is
A) maximax.
B) equally likely.
C) maximin.
D) decision making under certainty.
Answer: C
Diff: Moderate
38) Which of the following is true about the expected value of perfect information?
A) It is the amount you would pay for any sample study.
B) It is calculated as EMV minus EOL.
C) It is calculated as expected value with perfect information minus maximum EMV.
D) It is the amount charged for marketing research.
Answer: C
Diff: Moderate
39) Which of the following is not a characteristic of a good decision?

A) based on logic
B) considers all available data
C) employs appropriate quantitative techniques
D) always results in a favorable outcome
Answer: D
Diff: Moderate
Topic: INTRODUCTION
40) The following is a payoff table giving costs for various situations.
State 1 State 2 State 3

Alternative 1 45 37 83
What decision would an optimist make?

A) Alternative 1
B) Alternative 2
C) Alternative 3
D) Alternative 4
Answer: B
Diff: Moderate
Classification: Application

What decision would a pessimist make?

A) Alternative 1
B) Alternative 2
C) Alternative 3
D) Alternative 4
Answer: D
Diff: Moderate

What decision should be made based on the Laplace criterion?

A) Alternative 1
B) Alternative 2
C) Alternative 3
D) Alternative 4
Answer: D
Diff: Moderate

What decision should be made based on the minimax regret criterion?

A) Alternative 1
B) Alternative 2
C) Alternative 3
D) Alternative 4
Answer: B
Diff: Moderate

What are the regret values for Alternative 3 as read from State 1 to State 3?
A) 17, 16, 25
B) 29, 0, 7
C) 7, 32, 36
D) 23, 65, 91
Answer: C
Diff: Moderate
45) The following is a payoff table giving profits for various situations.

Probability 0.4 0.35 0.25
If a person were to use the expected monetary value criterion, what decision would be made?
A) Alternative 1
B) Alternative 2
C) Alternative 3
D) Alternative 4
Answer: C
Diff: Moderate

If a person selected Alternative 1, what would the expected profit be?

A) 51.7
B) 54.7
C) 55.0
D) 57.3
Answer: A
Diff: Easy

What is the expected value of perfect information?

A) 7.6
B) 8.4
C) 8.8
D) 9.2
Answer: C
Diff: Moderate
48) Consider the following payoff table.

Based upon these probabilities, a person would select Alternative 3. Suppose there is concern
about the accuracy of these probabilities. A few of the analysts feel that the likelihood of State 1
is higher and that the likelihood of State 2 is much lower. If the likelihood of State 2 is reduced
at the expense of State 1, how much lower can State 2's likelihood fall before Alternative 3 is no
longer optimal?
A) 0.05
B) 0.06
C) 0.07
D) 0.08
Answer: B
Diff: Difficult
49) Consider the following payoff table.
States of Nature
Alternatives A B
Alternative 1 100 150
Alternative 2 200 100
Probability 0.4 0.6
How much should be paid for a perfect forecast of the state of nature?
A) 170
B) 30
C) 10
D) 100
Answer: B
Diff: Moderate
States of Nature
Alternatives A B C
Do Nothing 0 0 0
The probabilities for states of nature A, B, and C are 0.3, 0.5, and 0.2, respectively. If a perfect
forecast of the future were available, what is the expected value with this perfect information?
A) 130
B) 160
C) 166
D) 36
Answer: C
Diff: Moderate
States of Nature
Alternatives A B C
Do Nothing 0 0 0
The probabilities for states of nature A, B, and C are 0.3, 0.5, and 0.2, respectively. If a perfect
forecast of the future were available, what is the expected value of perfect information (EVPI)?
A) 166
B) 0
C) 36
D) 40
Answer: C
Diff: Difficult
52) Nick has plans to open some pizza restaurants, but he is not sure how many to open. He has
prepared a payoff table to help analyze the situation.
States of Nature
Good Fair Poor
Alternatives Market Market Market
Open 1 380,000 70,000 - 400,000
Open 2 200,000 80,000 - 200,000
Do Nothing 0 0 0
As Nick does not know how his product will be received, he assumes that all three states of
nature are equally likely to occur. If he uses the equally likely criterion, what decision would he
make?
A) Open 1
B) Open 2
C) Good market
D) Fair market
Answer: B
Diff: Moderate
53) Nick has plans to open some pizza restaurants, but he is not sure how many to open. He has
prepared a payoff table to help analyze the situation.
States of Nature
Good Fair Poor
Alternatives Market Market Market
Open 1 380,000 70,000 - 400,000
Open 2 200,000 80,000 - 200,000
Do Nothing 0 0 0
Nick believes there is a 40 percent chance that the market will be good, a 30 percent chance that
it will be fair, and a 30 percent chance that it will be poor. A market research firm will analyze
market conditions and will provide a perfect forecast (they provide a money back guarantee).
What is the most that should be paid for this forecast?
A) $ 44,000
B) $ 53,000
C) $123,000
D) $176,000
Answer: C
Diff: Moderate
54) Which of the following is the fourth step of the "Six Steps in Decision Making"?
A) Select one of the mathematical decision theory models.
B) List the possible alternatives.
C) Apply the model and make your decision.
D) List the payoff or profit of each combination of alternatives and outcomes.
Answer: D
Diff: Moderate
55) Which of the following is not one of the steps considered in the "Six Steps in Decision
Making"?
A) Clearly define the problem at hand.
B) List the possible alternatives.
C) Apply the model and make your decision.
D) Evaluate the success of the decision.
Answer: D
Diff: Moderate
56) Optimistic decision makers tend to

A) magnify favorable outcomes.
B) ignore bad outcomes.
C) discount favorable outcomes.
D) A and B
Answer: D
Diff: Moderate
AACSB: Reflective thinking
57) Pessimistic decision makers tend to

A) magnify favorable outcomes.
B) ignore bad outcomes.
C) discount favorable outcomes.
D) A and B
Answer: C
Diff: Moderate
58) In decision theory, we call the payoffs resulting from each possible combination of
alternatives and outcomes
A) marginal values.
B) conditional values.
C) conditional probabilities.
D) Bayesian values.
Answer: B
Diff: Moderate
59) Another name for a decision table is a

A) payment table.
B) payout table.
C) payoff table.
D) pay-up table.
Answer: C
Diff: Easy
60) How are decision tables organized?

A) alternatives down the left, states of nature on top, payoffs inside
B) states of nature down the left, alternatives on top, payoffs inside
C) alternatives down the left, payoffs on top, states of nature inside
D) payoffs down the left, alternatives on top, states of nature inside
Answer: A
Diff: Easy
61) The three decision-making environments are decision making under
A) utility, risk, and certainty.
B) utility, risk, and uncertainty.
C) utility, certainty, and uncertainty.
D) risk, certainty, and uncertainty.
Answer: D
Diff: Easy
62) In decision making under ________, there are several possible outcomes for each alternative,
and the decision maker does not know the probabilities of the various outcomes.
A) risk
B) utility
C) certainty
D) uncertainty
Answer: D
Diff: Moderate
63) In decision making under ________, there are several possible outcomes for each alternative,
and the decision maker knows the probability of occurrence of each outcome.
A) risk
B) utility
C) certainty
D) probability
Answer: A
Diff: Moderate
64) The optimistic decision criterion is the criterion of
A) maximax.
B) maximin.
C) realism.
D) equally likely.
Answer: A
Diff: Moderate
65) The Hurwicz criterion is also called the criterion of

A) regret.
B) equality.
C) optimism.
D) realism.
Answer: D
Diff: Moderate
66) The equally likely criterion is also called the ________ criterion.
A) Hurwicz
B) uncertainty
C) Laplace
D) LaFlore
Answer: C
Diff: Moderate
Figure 1
67) Given this decision tree, alternatives emanate from

A) the node labeled 1.
B) the node labeled 2.
C) the node labeled 3.
D) the node labeled 4.
Answer: A
Diff: Easy
68) Given this decision tree, node 2 represents

A) an alternative.
B) a state of nature.
C) the optimal solution.
D) a non-optimal solution.
Answer: B
Diff: Easy
69) Given this decision tree, what can be said about this decision?
A) There are three alternatives and two states of nature.
B) There are eight decisions to be made.
C) There are two alternatives and three states of nature.
D) There are three payoffs.
Answer: C
Diff: Easy
70) A decision analyst began to sketch this decision tree at 8:30 this morning and now is just
returning from her lunch break (she had the blue plate special and highly recommends it). If she
resumes work on the decision tree at the point on the tree labeled 4, what is least likely to go
there?
A) a positive payoff
B) a decision node
C) a state of nature node
D) a negative payoff
Answer: C
Diff: Moderate
71) The expected value of sample information (EVSI) can be used to

A) establish a maximum amount to spend on additional information.
B) calculate conditional probabilities.
C) establish risk avoidance.
D) provide points on a utility curve.
Answer: A
Diff: Moderate
72) A plant manager considers the operational cost per hour of five machine alternatives. The
cost per hour is sensitive to three potential weather conditions: cold, mild, and warm. The
following table represents the operations cost per hour for each alternative-state of nature
combination:
States of Nature
Weather related cost per hour
Alternatives Cold cost/day Mild cost/day Warm cost/day
Machine 1 $50 $40 $45
Machine 2 $45 $42 $47
Machine 3 $40 $35 $54
Machine 4 $60 $25 $48
Machine 5 $45 $40 $45
Using the optimistic criterion, which alternative is best?

A) Machine 1
B) Machine 2
C) Machine 3
D) Machine 4
Answer: D
Diff: Moderate
combination:
States of Nature
Machine 1 $50 $40 $45
Machine 2 $45 $42 $47
Machine 3 $40 $35 $54
Machine 4 $60 $25 $48
Machine 5 $45 $40 $45
Using the pessimistic criterion, which alternative is best?

A) Machine 2
B) Machine 3
C) Machine 4
D) Machine 5
Answer: D
Diff: Moderate
combination:
States of Nature
Machine 1 $50 $40 $45
Machine 2 $45 $42 $47
Machine 3 $40 $35 $54
Machine 4 $60 $25 $48
Machine 5 $45 $40 $45
Using the equally likely criterion, which alternative is best?

A) Machine 1
B) Machine 2
C) Machine 3
D) Machine 4
Answer: C
Diff: Moderate
combination:
States of Nature
Machine 1 $50 $40 $45
Machine 2 $45 $42 $47
Machine 3 $40 $35 $54
Machine 4 $60 $25 $48
Machine 5 $45 $40 $45
Assume that for a randomly selected day, there is a 30% probability of cold weather, 50%
probability of mild weather, and 20% probability of warm weather. What alternative is best using
EMV?
A) Machine 1
B) Machine 2
C) Machine 3
D) Machine 4
Answer: D
Diff: Moderate
combination:
States of Nature
Machine 1 $50 $40 $45
Machine 2 $45 $42 $47
Machine 3 $40 $35 $54
Machine 4 $60 $25 $48
Machine 5 $45 $40 $45
Assume that for a randomly selected day, there is a 30% probability of cold weather, 50%
probability of mild weather, and 20% probability of warm weather. What is the EVPI?
A) $5.8
B) $6.6
C) $1.6
D) $3.2
Answer: B
Diff: Moderate
77) A market research survey is available for $10,000. Using a decision tree analysis, it is found
that the expected monetary value with no survey is $62,000. If the expected value of sample
information is -$7,000, what is the expected monetary value with the survey?
A) $45,000
B) $62,000
C) -$17,000
D) $55,000
Answer: A
Diff: Moderate
78) In the construction of decision trees, which of the following shapes represents a state of
nature node?
A) square
B) circle
C) diamond
D) triangle
Answer: B
Diff: Easy
79) In the construction of decision trees, which of the following shapes represents a decision
node?
A) square
B) circle
C) diamond
D) triangle
Answer: A
Diff: Easy
80) Bayes' theorem enables decision makers to revise probabilities based on

A) perfect information.
B) knowing, ahead of time, the actual outcome of the decision.
C) additional information.
D) measurements of utility.
Answer: C
Diff: Moderate
81) In Bayesian analysis, conditional probabilities are also known as which of the following?
A) anterior probabilities
B) posterior probabilities
C) prior probabilities
D) marginal probabilities
Answer: B
Diff: Moderate
82) A company is considering producing a new children's bar soap. A market research firm has
told the company that if they perform a survey, a positive survey of a favorable market occurs 65
percent of the time. That is, P(positive survey | favorable market) = 0.65. Similarly, 40 percent of
the time the survey falsely predicts a favorable market; thus, P(positive survey | unfavorable
market) = 0.40. These statistics indicate the accuracy of the survey. Prior to contacting the
market research firm, the company's best estimate of a favorable market was 50 percent. So,
P(favorable market) = 0.50 and P(unfavorable market) = 0.50. Using Bayes' theorem, determine
the probability of a favorable market given a favorable survey.
A) 0.62
B) 0.38
C) 0.53
D) 0.65
Answer: A
Diff: Moderate
83) A decision sciences professor defines the P(A) = the likelihood one of his students will be
bitten by a monkey on his trip to India and P(B) = an Indian monkey carries rabies. Which of
these expressions represents the likelihood that given a monkey doesn't have rabies, it will bite
his student?
A) P(B|A')
B) P(A'|B')
C) P(A|B')
D) P(A'|B)
Answer: C
Diff: Moderate
84) The Hurwicz criterion coefficient of realism measures the decision maker's degree of
A) utility.
B) pessimism.
C) certainty.
D) optimism.
Answer: D
Diff: Moderate
85) What is the range of the Hurwicz criterion coefficient of realism α?

A) 1 to 100
B) 1 to 10
C) 0 to 10
D) 0 to 1
Answer: D
Diff: Moderate
86) Utilization of Bayes' theorem requires the use of all but

A) prior probabilities.
B) conditional probabilities.
C) posterior probabilities.
D) expected monetary values (EMV).
Answer: D
Diff: Moderate
87) A risk avoider is a person for whom the utility of an outcome

A) decreases as the monetary value increases.
B) stays the same as monetary value increases.
C) increases at an increasing rate as the monetary value increases.
D) increases at a decreasing rate as monetary value increases.
Answer: D
Diff: Moderate
88) A utility curve showing utility increasing at an increasing rate as the monetary value
increases represents
A) a risk avoider.
B) utility assessment.
C) a risk seeker.
D) conditional values.
Answer: C
Diff: Moderate
89) In constructing a utility curve

A) a comparison is made of the different amounts of money at different times.
B) the certainty of a certain amount is compared with the willingness to gamble that amount on a
larger amount.
C) one takes the risk out of gambling.
D) inflation plays a critical part in the evaluation.
Answer: B
Diff: Moderate
90) Utility values typically range from

A) -1 to 1.
B) 1 to 10.
C) 0 to 1.
D) 1 to 100.
Answer: C
Diff: Moderate
91) A rational decision maker must choose between two alternatives. Alternative 1 has a higher
EMV than Alternative 2, but the decision maker chooses Alternative 2. What might explain why
this occurs?
A) Alternative 2 may have a higher expected utility.
B) Alternative 1 may have a lower expected opportunity loss.
C) The probabilities are not known.
D) A rational decision maker could not possibly choose alternative 2.
Answer: A
Diff: Moderate
92) Robert Weed is considering purchasing life insurance. He must pay a $180 premium for a
$100,000 life insurance policy. If he dies this year, his beneficiary will receive $100,000. If he
does not die this year, the insurance company pays nothing and Robert must consider paying
another premium next year. Based on actuarial tables, there is a 0.001 probability that Robert
will die this year. If Robert wishes to maximize his EMV, he would not buy the policy if the
EMV were negative for him. He has determined that the EMV is, negative for him, but decides
to purchase the insurance anyway. Why?
A) He believes that the actual likelihood of his death occurring in the next twelve months is
really much greater than the actuarial estimate.
B) While the EMV is negative, the utility gained from purchasing the insurance is positive, and
high.
C) Mr. Weed is not rational.
D) A or C
Answer: B
Diff: Moderate
93) It is sometimes said that, "Those who gamble the most are the ones who can least afford to
lose." These people gamble because
A) the EMV is positive.
B) the EMV is negative.
C) the gambler has no family to consider if he/she dies.
D) there is utility other than monetary to consider.
Answer: D
Diff: Moderate
94) A manager is deciding whether or not to build a small facility. Demand is uncertain and can
be either at a high or low level. If the manager chooses a small facility and demand is low, the
payoff is $300. If the manager chooses a small facility and demand is high, the payoff is $100.
On the other hand, if the manager chooses a large facility and demand is low, the payoff is -
$200, but if demand is high, the payoff is $800.
(a) What would be the best decision based on the maximax criterion?
(b) What would be the best decision based on the maximin criterion?
(c) What would be the best decision based on the minimax regret?
Answer: large facility - highest overall payoff = $800
small facility - highest minimum potential payoff = $100
large facility - lowest maximum regret = $500
Diff: Easy
95) A manager is deciding whether or not to build a small facility. Demand is uncertain and can
be either at a high or low level. If the manager chooses a small facility and demand is low, the
payoff is $100. If the manager chooses a small facility and demand is high, the payoff is $300.
On the other hand, if the manager chooses a large facility and demand is low, the payoff is -
$200, but if demand is high, the payoff is $800.
(a) What would be the best decision based on the Laplace criterion?
(b) What would be the best decision based on Hurwicz's criterion of realism using α = 0.6?
Answer: large facility - equally weighted payoff = $300
large facility - weighted average = $400
Diff: Easy
96) A concessionaire for the local ballpark has developed a table of conditional values for the
various alternatives (stocking decision) and states of nature (size of crowd). All values are in US
Dollars.
Large Average Small

Probability .3 .5 .2
Alternative 1 9,000 12,000 -2,000
Alternative 2 22,000 6,000 6,000
Alternative 3 15,000 12,000 5,000
If the probabilities associated with the states of nature are 0.30 for a large crowd, 0.50 for an
average crowd, and 0.20 for a small crowd, determine:
(a) the alternative that provides the greatest expected monetary value (EMV).
(b) the expected value of perfect information (EVPI).
Answer: The maximum EMV is Alternative 3 at $11,500
EVPI = 13,800 -11,500 = 2,300
Diff: Moderate
97) A concessionaire for the local ballpark has developed a table of conditional values for the
various alternatives (stocking decision) and states of nature (size of crowd).
Large Average Small

Probability .3 .5 .2
Alternative 1 9,000 12,000 -2,000
Alternative 2 22,000 6,000 6,000
Alternative 3 15,000 12,000 5,000
If the probabilities associated with the states of nature are 0.30 for a large crowd, 0.50 for an
average crowd, and 0.20 for a small crowd, determine:
(a) the opportunity loss table.
(b) minimum expected opportunity loss (EOL).
Answer: Opportunity loss table
Large Average Small

Alternative 1 13,000 0 8,000
Alternative 2 0 6,000 0
Alternative 3 7,000 0 1,000
(b) minimum EOL = $6,000 with Alternative 2

Diff: Moderate
98) The concessionaire for Carnegie Hall has developed a table of conditional values for the
Large Average Small

Alternative 1 9,000 12,000 -2,000
Alternative 2 22,000 6,000 6,000
Alternative 3 15,000 12,000 5,000
The concessionaire has no idea what sort of crowd might materialize — it has been decades since
the Del Aires last performed together, but there has been a resurgence in interest thanks to a re-
release of the classic movie Horror of Party Beach. Determine:
(a) the opportunity loss table.
(b) minimum expected opportunity loss (EOL).
Answer: Opportunity loss table
Large Average Small
Alternative 1 13,000 0 8,000
Alternative 2 0 6,000 0
Alternative 3 7,000 0 1,000
(b) minimum EOL = $6,000 with Alternative 2

Diff: Moderate
Large Average Small

Alternative 1 9,000 12,000 -2,000
Alternative 2 22,000 6,000 6,000
Alternative 3 15,000 12,000 5,000
(a) the optimal alternative if the concessionaire is an optimist.
(b) the optimal alternative if the concessionaire is a pessimist.
Answer:
(a) The maximax (optimist's) alternative is alternative 2 at $22,000.
(b) The maximin (pessimist's) alternative is alternative 2 at $6,000.
Diff: Moderate
Large Average Small

Alternative 1 9,000 12,000 -2,000
Alternative 2 22,000 6,000 6,000
Alternative 3 15,000 12,000 5,000
(a) the expected value of perfect information for this scenario.
(b) the optimal choice using the Laplace criterion.
Answer:
(a) the EVPI = $2,000 = $13,333.33-$11,333.33
(b) the Laplace criterion suggests alternative 2 at $11,333.33
Diff: Moderate
101) A manager needs to hire short-term employees to meet production demands. The manager
would like to hire one of three possible short-term workers.
States of Nature
(Worker hours demanded)
Alternatives 10 hr total pay 20 hr total pay 30 hr total pay
Worker 1 $1,000 $1,800 $2,400
Worker 2 $900 $1,800 $2,500
Worker 3 $950 $1,750 $2,550
(a) Which alternative is most optimistic?

(b) Which alternative is most pessimistic?
(c) Using the Hurwicz criterion with a coefficient of realism, α = 0.70, what is the best
alternative?
Answer:
(a) Worker 2 - $900
(b) Worker 1 - $2400
(c) Worker 2 - $1380
Diff: Moderate
102) A manager needs to hire short-term employees to meet production demands. The manager
would like to hire one of three possible short-term workers. Ten hours are demanded with 50%
probability, 20 hours are demanded with 30% probability, and 30 hours are demanded with 20%
probability. The table below represents the alternatives and possible states of nature.
States of Nature
(Worker hours demanded)
Alternatives 10 hr total pay 20 hr total pay 30 hr total pay
Worker 1 $1,000 $1,800 $2,400
Worker 2 $900 $1,800 $2,500
Worker 3 $950 $1,750 $2,550
Which alternative will minimize the expected monetary value?

What is the expected value of perfect information?
Answer: Worker 2 - EMV = $1490
EVPI = $1490 - $1455 = $35
Diff: Moderate
103) The ABC Co. is considering a new consumer product. They believe there is a probability of
0.4 that the XYZ Co. will come out with a competitive product. If ABC adds an assembly line
for the product and XYZ does not follow with a competitive product, their expected profit is
$40,000; if they add an assembly line and XYZ does follow, they still expect a $10,000 profit. If
ABC adds a new plant addition and XYZ does not produce a competitive product, they expect a
profit of $600,000; if XYZ does compete for this market, ABC expects a loss of $100,000.
(a) Determine the EMV of each decision.
(b) Determine the EOL of each decision.
(c) Compare the results of (a) and (b).
(d) Calculate the EVPI.
Answer:
(a)
Decision EMV
add assembly line $28,000
plant addition $320,000
do nothing $0
(b)
Decision EOL
add assembly line $336,000
plant addition $44,000
do nothing $364,000
(c) The plant addition is best for both models. The maximum EMV alternative is always the
same as the minimum EOL alternative.
(d) EVPI = 44,000
Diff: Moderate
104) The ABC Co. is considering a new consumer product. They have no idea whether or not the
XYZ Co. will come out with a competitive product. If ABC adds an assembly line for the
product and XYZ does not follow with a competitive product, their expected profit is $40,000; if
they add an assembly line and XYZ does follow, they still expect a $10,000 profit. If ABC adds
a new plant addition and XYZ does not produce a competitive product, they expect a profit of
$600,000; if XYZ does compete for this market, ABC expects a loss of $100,000.
Calculate Hurwicz's criterion of realism using αs of a. 0.7, b. 0.3, and c. 0.1.
Answer:
Criterion of Realism
Decision a. α = 0.7 b. α = 0.3 c. α = 0.1
add assembly line $31,000 $19,000 $13,000
plant addition $390,000 $110,000 - $30,000
do nothing $0 $0 $0
Diff: Moderate
105) Barbour Electric is considering the introduction of a new product. This product can be
produced in one of several ways: (a) using the present assembly line at a cost of $25 per unit, (b)
using the current assembly line after it has been overhauled (at a cost of $10,000) with a cost of
$22 per unit; and (c) on an entirely new assembly line (costing $30,000) designed especially for
the new product with a per unit cost of $20. Barbour is worried, however, about the impact of
competition. If no competition occurs, they expect to sell 15,000 units the first year. With
competition, the number of units sold is expected to drop to 9,000. At the moment, their best
estimate is that there is a 40% chance of competition. They have decided to make their decision
based on the first year sales.
(a) Develop the decision table (EMV).
(b) Develop a decision table (EOL).
(c) What should they do?
Answer:
(a)
No
Alternative Competition Competition EMV
P = 0.60 P = 0.40
(a) Present line $375,000 $225,000 $315,000
(b) Overhauled line $340,000 $208,000 $287,200
(c) New line $330,000 $210,000 $282,000
(b)
No
Alternative Competition Competition EMV
P = 0.60 P = 0.40
(a) Present line $45,000 $17,000 $33,800
(b) Overhauled line $10,000 $0 $6,000
(c) New line $0 $2,000 $800
(c) They should build the new line.

Diff: Moderate
106) The following payoff table provides profits based on various possible decision alternatives
and various levels of demand.
States of Nature
Demand
Alternatives Low Medium High
The probability of a low demand is 0.4, while the probability of a medium and high demand is
each 0.3.
(a) What decision would an optimist make?
(b) What decision would a pessimist make?
(c) What is the highest possible expected monetary value?
(d) Calculate the expected value of perfect information for this situation.
Answer:
(a) Alternative 3
(b) Alternative 2
(c) Alternative 1 maximum EMV = 110
(d) EVPI = 117 - 110 = 7
Diff: Moderate
Topic: DECISION MAKING UNDER UNCERTAINTY AND DECISION MAKING UNDER
RISK
LO: 3.3: Make decisions under uncertainty. 3.4: Use probability values to make decisions under
risk.
107) The ABC Co. is considering a new consumer product. They believe that the XYZ Co. may
come out with a competing product. If ABC adds an assembly line for the product and XYZ does
not follow with a competitive product, their expected profit is $40,000; if they add an assembly
line and XYZ does follow, they still expect a $10,000 profit. If ABC adds a new plant addition
and XYZ does not produce a competitive product, they expect a profit of $600,000; if XYZ does
compete for this market, ABC expects a loss of $100,000. For what value of probability that
XYZ will offer a competing product will ABC be indifferent between the alternatives?
Answer: Let X = probability XYZ offers a competing product. Then:
EMV(assembly line) = $10,000X + $40,000(1 - X)

EMV(addition) = -$100,000X + $600,000(1 - X) or:
$10,000X + $40,000(1 - X) = -$100,000 * X + $600,000(1 - X) or:
$10,000X - $40,000X + $40,000 = -$100,000X - $600,000X + $600,000
-$30,000X + $700,000X = $600,000 - $40,000
$670,000X = $560,000
X = $560,000/$670,000 = 0.836
If the probability that XYZ will offer a competing product is estimated to be 0.836, then ABC
will be indifferent between the two alternatives. If the probability that XYZ will offer a
competing product is estimated to be less than 0.836, then ABC should invest in the addition.
Diff: Moderate
108) A company is considering expansion of its current facility to meet increasing demand. A
major expansion would cost $500,000, while a minor expansion would cost $200,000. If demand
is high in the future, the major expansion would result in an additional profit of $800,000, but if
demand is low, then there would be a loss of $500,000. If demand is high, the minor expansion
will result in an increase in profits of $200,000, but if demand is low, then there is a loss of
$100,000. The company has the option of not expanding. For what probability of a high demand
will the company be indifferent between the two expansion alternatives?
Answer:
States of Nature
Alternatives Demand is high Demand is low
Major expansion $800,000 - $500,000 -$500,000 - $500,000
Minor expansion $200,000 - $200,000 -$100,000 - $200,000
Do nothing $0 $0
States of Nature
Alternatives Demand is high Demand is low
Major expansion $300,000 -$1,000,000
Minor expansion $0 -$300,000
Do nothing $0 $0
If we define X = probability of high demand, then:
$300,000X - $1,000,000(1 - X) = $0X - $300,000(1 - X)
X = 0.7
For a probability of high demand equal to 0.7, the decision maker would be indifferent between
the two expansion alternatives.
Diff: Moderate
109) Orders for clothing from a particular manufacturer for this year's Christmas shopping
season must be placed in February. The cost per unit for a particular dress is $20 while the
anticipated selling price is $50. Demand is projected to be 50, 60, or 70 units. There is a 40
percent chance that demand will be 50 units, a 50 percent chance that demand will be 60 units,
and a 10 percent chance that demand will be 70 units. The company believes that any leftover
goods will have to be scrapped. How many units should be ordered in February?
Answer:
Payoff Table:
States of Nature
Demand (units)
Alternatives 50 60 70
Order 50 1500 1500 1500
Order 60 1300 1800 1800
Order 70 1100 1600 2100
Probabilities: 0.4 0.5 0.1
EMV(50) = .4(1500) + .5(1500) + .1(1500) = 1500

EMV(60) = .4(1300) + .5(1800) + .1(1800) = 1600
EMV(70) = .4(1100) + .5(1600) + .1(2100) = 1450
Thus, 60 units should be ordered.

Diff: Moderate
110) Suppose that the payoff from an investment depends upon market conditions. A great
market has a payoff of $200,000, a normal market has a payoff of $100,000, and a poor market
has a payoff of $20,000. Using an α-value of 0.3, what is the criterion of realism value?
Answer: 0.3($200,000) + 0.7($20,000) = $74,000
Diff: Easy
111) A market research survey is available for $5,000. Using a decision tree analysis, it is found
that the expected monetary value with no survey is $49,000. If the expected value of sample
information is -$4,000, what is the expected monetary value with the survey?
Answer: EV with SI = 49,000 - $4,000 + 5,000 = $50,000
Diff: Easy
112) David S Pumpkins is planning to open a sporting goods store. However, the initial
investment is $120,000. He currently has this money in a certificate of deposit earning 10
percent. He may leave it there if he decides not to open the store. If he opens the store and it is
successful he will generate a profit of $50,000. If it is not successful, he will lose $90,000. What
would the probability of a successful store have to be for David to prefer this to investing in a
CD?
Answer: p(50,000) - (1 - p)(90,000) > 0.10(120,000), therefore p > 0.7286
Diff: Moderate
113) You are considering adding a new food product to your store for resale. You are certain
that, in a month, minimum demand for the product will be 6 units, while maximum demand will
be 8 units. (Unfortunately, the new product has a one-month shelf life and is considered to be
waste at the end of the month.) You will pay $60/unit for this new product while you plan to sell
the product at a $40/unit profit. The estimated demand for this new product in any given month
is 6 units(p = 0.1), 7 units(p = 0.4), and 8 units(p = 0.5). Using EMV analysis, how many units of
the new product should be purchased for resale?
Answer: EMV(purchase 6 for resale) = 6(40)(0.1) + 6(40)(0.4) + 6(40)(0.5) = 240
EMV(purchase 7 for resale) = [6(40) - 60](0.1) + 7(40)(0.4) + 7(40)(0.5) = 270
EMV(purchase 8 for resale) = [6(40) - 2(60)](0.1) + [7(40) - 60](0.4) + 8(40)(0.5) = 260
Choose to purchase 7 units for resale (largest EMV)

Diff: Moderate
114) Mark M. Upp has just been fired as the university bookstore manager for setting prices too
low (only 20 percent above suggested retail). He is considering opening a competing bookstore
near the campus, and he has begun an analysis of the situation. There are two possible sites under
consideration. One is relatively small, while the other is large. If he opens at Site 1 and demand
is good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens
at Site 2 and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if
demand is low. He also has the option of not opening at either site. He believes that there is a 50
percent chance that demand will be high. A market research study will cost $5,000. The
probability of a good demand given a favorable study is 0.8. The probability of a good demand
given an unfavorable study is 0.1. There is a 60 percent chance that the study will be favorable.
(a) Should Mark use the study? Why?
(b) If the study is done and the results are favorable, what would Mark's expected profit be?
Answer:
(a) Yes, he should use the study. His EMV with the study is $29,800 while the highest EMV
without the study is $25,000.
(b) Given a favorable survey result, Mark would select Site 2 and have an EMV of $53,000.
Diff: Moderate
at Site 2 and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if
demand is low. He also has the option of not opening either. He believes that there is a 50
percent chance that demand will be high. Mark can purchase a market research study. The
probability of a good demand given a favorable study is 0.8. The probability of a good demand
given an unfavorable study is 0.1. There is a 60 percent chance that the study will be favorable.
Should Mark use the study? Why? What is the maximum amount Mark should be willing to pay
for this study? What is the maximum amount he should pay for any study?
Answer: Yes, he should use the study. His EMV with the study is $34,800 while the highest
EMV without the study is $25,000. He should pay no more than $9,800 for this study. He should
pay no more than $10,000 for a "perfect" study.
Diff: Moderate
116) Before a marketing research study was done, John Colorado believed there was a 50/50
chance that his music store would be a success. The research team determined that there is a 0.9
probability that the marketing research will be favorable given a successful music store. There is
also a 0.8 probability that the marketing research will be unfavorable given an unsuccessful
music store.
(a) If the marketing research is favorable, what is the revised probability of a successful music
store?
(b) If the marketing research is unfavorable, what is the revised probability of a successful music
store?
Answer:
(a) 0.82
(b) 0.11
Diff: Moderate
117) Before a market survey is done, there is a 50/50 chance that a new soccer supply store
would be a success. The people doing the survey have determined that there is a 0.9 probability
that the survey will be favorable given a successful store. There is also a 0.75 probability that the
survey will be unfavorable given an unsuccessful store. What is the probability that the survey
will be unfavorable?
Answer: (1 − .9)(.5) + (.75)(.5) = 0.425
Diff: Moderate
118) Before a marketing research study was done, John Colorado believed there was a 50/50
chance that his music store would be a success. The research team determined that there is a 0.9
probability that the marketing research will be favorable given a successful music store. There is
also a 0.8 probability that the marketing research will be unfavorable given an unsuccessful
music store.
(a) If the marketing research is favorable, what is the revised probability of an unsuccessful
music store?
(b) If the marketing research is unfavorable, what is the revised probability of an unsuccessful
music store?
Answer:
(a) 0.18
(b) 0.89
Diff: Moderate
consideration. One is relatively small while the other is large. If he opens at Site 1 and demand is
good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at
Site 2 and demand is high he will generate a profit of $80,000, but he will lose $30,000 if
demand is low. He also has decided that he will open at one of these sites. He believes that there
is a 60 percent chance that demand will be high. He assigns the following utilities to the different
profits:
U(50,000) = 0.72 U(-10,000) = 0.22

U(80,000) = 1 U(-30,000) = 0
Using expected utility theory, what should Mark do?

Answer: Expected utility (Site 1) = 0.6(0.72) + 0.4(0.22) = 0.52
Expected utility (Site 2) = 0.6(1.00) + 0.4(0.00) = 0.60
Therefore he should open at Site 2.
Diff: Moderate
120) Mark M. Upp has just been fired as the university book store manager for setting prices too
at Site 2 and demand is high he will generate a profit of $80,000, but he will lose $30,000 if
demand is low. He also has decided that he will open at one of these sites. He believes that there
is a 50 percent chance that demand will be high. He assigns the following utilities to the different
profits:
U(50,000) = ? U(-10,000) = 0.22

U(80,000) = 1 U(-30,000) = 0
For what value of utility for $50,000, U(50000), will Mark be indifferent between the two
alternatives?
Answer: Expected utility (Site 1) = 0.5X + 0.5(0.22)
Expected utility (Site 2) = 0.5(1) + 0.5(0) = 0.50
Therefore: 0.5X + 0.5(0.22) = 0.50
or: 0.5X = 0.50 - 0.11 = 0.39
and: X = 0.39/0.5 = 0.78
Therefore, if Mark has U(50,000) = 0.78 he will be indifferent between the two alternatives.
Diff: Moderate
121) Suppose that the payoff from an investment depends upon market conditions. A great
market has a payoff of $200,000, a normal market has a payoff of $100,000, and a poor market
has a payoff of $20,000. What is the Laplace criterion value?
Answer: ($200,000 + $100,000 + $20,000) / 3 = $320,000/3 = $106,667
Diff: Easy
122) Briefly describe decision making under certainty.

Answer: Decision makers know with certainty of the consequence of every alternative or
decision choice.
Diff: Moderate
123) Briefly describe decision making under risk.
Answer: There are several possible outcomes for each alternative, and the decision maker knows
the probability of occurrence of each outcome.
Diff: Moderate
124) A decision maker is faced with a decision making under uncertainty situation in a national
election. He lays out his decision table and begins to enter equal probabilities for all states of
nature into his spreadsheet. He feels uneasy doing so, reasoning that it can't possibly be as likely
that one candidate will win every tossup state. Advise the decision maker on an appropriate
course of action in completing the decision table.
Answer: If the decision maker recognizes that one state of nature is less likely than another, then
this cannot truly be an appropriate application of decision making under uncertainty. The
decision maker must know something if he realizes it is unreasonable to enter equal probabilities
for all states of nature. Thus, the decision maker should treat this as decision making under risk
and proceed with the analysis.
Diff: Moderate
125) List the six steps in decision making.

Answer: Clearly define the problem at hand.
List the possible alternatives.
Identify the possible outcomes or states of nature.
List the payoff or profit of each combination of alternatives and outcomes.
Select one of the mathematical decision theory models.
Apply the model and make your decision.
Diff: Moderate
126) Which is the more crucial mistake in the decision-making process — estimating the payoffs
poorly or omitting an important alternative?
Answer: Answers will vary — the authors note that leaving out important alternatives is a big
mistake. However, faulty estimates of payoffs may lead to incorrect decisions even if sensitivity
analysis is performed.
Diff: Moderate
127) What is the difference between the Expected Monetary Value and Expected Value with
Perfect Information?
Answer: The Expected Monetary Value looks at the best long run, weighted average outcome by
probability, while the Expected Value with Perfect Information assumes that one will have the
ability to select the best alternative, knowing the probabilistic outcome.
Diff: Moderate
128) Solve this decision tree.
Answer: Expanding the factory has an expected payoff of 3.6M-1.5M = $2.1M; Not expanding
has a payoff of 1.8M-0 = 1.8M. Therefore, the factory should be expanded.
Diff: Moderate
129) Briefly describe EVSI.
Answer: EVSI = EMV (best decision with sample information) - EMV (of best decision without
sample information)
Diff: Moderate
130) Why do people make decisions that don't maximize their expected monetary value? Explain
why and offer three examples of such behavior.
Answer: They do this because the monetary value is not always a true indicator of the overall
value of the result of the decision. The overall worth of a particular outcome is called utility, and
rational people make decisions that maximize the expected utility. Although at times the
monetary value is a good indicator of utility, there are other times when it is not. This is
particularly true when some of the values involve an extremely large payoff or an extremely
large loss. Also, some things cannot be quantified easily and EMV has difficulty capturing
altruistic behavior. Examples will vary, but could include quality of life issues such as forgoing a
higher salary to spend time with family or live in a particular region of the country, or
exchanging your own opportunities for those of your children.
Diff: Moderate
131) Describe the utility curve of a risk avoider.

Answer: utility increasing at a decreasing rate as the monetary value increases
Diff: Moderate
132) List the five major decision criteria used when making decisions under uncertainty.
Answer: (1) maximax (optimistic), (2) maximin (pessimistic), (3) criterion of realism (Hurwicz),
(4) equally likely (Laplace), and (5) minimax regret
Diff: Moderate

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Quantitative Analysis for Management, 13e (Render et al.

3) The decision maker can control states of nature.

8) Sensitivity analysis assumes no increasing or decreasing economies of scale.

14) A decision table is sometimes called a payout table.

26) Utility values typically range from -1 to +1.

35) Expected monetary value (EMV) is

39) Which of the following is not a characteristic of a good decision?

State 1 State 2 State 3

What decision would an optimist make?

State 1 State 2 State 3

What decision would a pessimist make?

State 1 State 2 State 3

What decision should be made based on the Laplace criterion?

State 1 State 2 State 3

What decision should be made based on the minimax regret criterion?

State 1 State 2 State 3

State 1 State 2 State 3

State 1 State 2 State 3

If a person selected Alternative 1, what would the expected profit be?

State 1 State 2 State 3

What is the expected value of perfect information?

State 1 State 2 State 3

49) Consider the following payoff table.

56) Optimistic decision makers tend to

57) Pessimistic decision makers tend to

59) Another name for a decision table is a

60) How are decision tables organized?

65) The Hurwicz criterion is also called the criterion of

67) Given this decision tree, alternatives emanate from

68) Given this decision tree, node 2 represents

71) The expected value of sample information (EVSI) can be used to

Using the optimistic criterion, which alternative is best?

Using the pessimistic criterion, which alternative is best?

Using the equally likely criterion, which alternative is best?

80) Bayes' theorem enables decision makers to revise probabilities based on

85) What is the range of the Hurwicz criterion coefficient of realism α?

86) Utilization of Bayes' theorem requires the use of all but

87) A risk avoider is a person for whom the utility of an outcome

89) In constructing a utility curve

90) Utility values typically range from

Large Average Small

Large Average Small

Large Average Small

(b) minimum EOL = $6,000 with Alternative 2

Large Average Small

(b) minimum EOL = $6,000 with Alternative 2

Large Average Small

Large Average Small

(a) Which alternative is most optimistic?

Which alternative will minimize the expected monetary value?

(c) They should build the new line.

EMV(assembly line) = $10,000X + $40,000(1 - X)

$10,000X + $40,000(1 - X) = -$100,000 * X + $600,000(1 - X) or:

$10,000X - $40,000X + $40,000 = -$100,000X - $600,000X + $600,000

-$30,000X + $700,000X = $600,000 - $40,000

If we define X = probability of high demand, then:

$300,000X - $1,000,000(1 - X) = $0X - $300,000(1 - X)

EMV(50) = .4(1500) + .5(1500) + .1(1500) = 1500

Thus, 60 units should be ordered.