Decision Analysis: To Accompany
Decision Analysis: To Accompany
Decision Analysis: To Accompany
Decision Analysis
To accompany
Quantitative Analysis for Management, Tenth Edition,
by Render, Stair, and Hanna © 2008 Prentice-Hall, Inc.
Power Point slides created by Jeff Heyl © 2009 Prentice-Hall, Inc.
Introduction
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 200,000 –180,000
Do nothing 0 0
Table 3.1
1. Maximax (optimistic)
2. Maximin (pessimistic)
3. Criterion of realism (Hurwicz)
4. Equally likely (Laplace)
5. Minimax regret
Table 3.2
© 2009 Prentice-Hall, Inc. 3–9
Maximin
Used to find the alternative that maximizes
the minimum payoff
Locate the minimum payoff for each alternative
Select the alternative with the maximum
number
STATE OF NATURE
FAVORABLE UNFAVORABLE MINIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large 200,000 –180,000 –180,000
plant
Construct a small 100,000 –20,000 –20,000
plant
Do nothing 0 0 0
Table 3.3
Maximin
© 2009 Prentice-Hall, Inc. 3 – 10
Criterion of Realism (Hurwicz)
A weighted average compromise between
optimistic and pessimistic
Select a coefficient of realism
Coefficient is between 0 and 1
A value of 1 is 100% optimistic
Compute the weighted averages for each
alternative
Select the alternative with the highest value
STATE OF NATURE
FAVORABLE UNFAVORABLE ROW
ALTERNATIVE MARKET ($) MARKET ($) AVERAGE ($)
Construct a large 200,000 –180,000 10,000
plant
Construct a small 100,000 –20,000 40,000
plant
Equally likely
Do nothing 0 0 0
Table 3.5
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 0 180,000
Construct a small plant 100,000 20,000
Do nothing 200,000 0
Table 3.7
© 2009 Prentice-Hall, Inc. 3 – 15
Minimax Regret
STATE OF NATURE
FAVORABLE UNFAVORABLE MAXIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large
0 180,000 180,000
plant
Construct a small
100,000 20,000 100,000
plant
Minimax
Do nothing 200,000 0 200,000
Table 3.8
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($) EMV ($)
Construct a large
200,000 –180,000 10,000
plant
Construct a small 100,000 –20,000 40,000
plant
Do nothing 0 0 0
Probabilities 0.50 0.50
Construct a small
plant 100,000 -20,000 40,000
Do nothing 0 0 0
Compute EVwPI
The best alternative with a favorable market is to build a large
plant with a payoff of $200,000. In an unfavorable market the
choice is to do nothing with a payoff of $0
EVwPI = ($200,000)*.5 + ($0)(.5) = $100,000
Compute EVPI = EVwPI – max EMV = $100,000 - $40,000 = $60,000
The most we should pay for any information is $60,000
© 2009 Prentice-Hall, Inc. 3 – 24
In-Class Example:
EVPI Solution
EVPI = EVwPI - max(EMV)
State of Nature
Alternative Favorable Unfavorable
Market ($) Market ($)
Construct a
200,000 -180,000
large plant
Construct a
100,000 -20,000
small plant
Do nothing 0 0
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($) EOL
200,000 -
Construct a large plant 0-(-180,000) 90,000
200,000
200,000 -
Construct a small plant 0-(-20,000) 60,000
100,000
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($) EOL
Construct a large
0 180,000 90,000
plant
Construct a small
100,000 20,000 60,000
plant
Do nothing 200,000 0
100,000
Probabilities 0.50 0.50
Do nothing 200,000 0
100,000
Probabilities
Table 3.10 0.50 0.50
Minimum EOL
EOL (large plant)= (0.50)($0) + (0.50)($180,000) = $90,000
$300,000
–$200,000
Figure 3.1
Point 2:
EMV(small plant) = EMV(large plant)
$120,000 P $20,000 $380,000 P $180,000
160,000
P 0.615
260,000
–$200,000
Figure 3.1
© 2009 Prentice-Hall, Inc. 3 – 36
Decision Trees
Any problem that can be presented in a
decision table can also be graphically
represented in a decision tree
Decision trees are most beneficial when a
sequence of decisions must be made
All decision trees contain decision points
or nodes and state-of-nature points or
nodes
A decision node from which one of several
alternatives may be chosen
A state-of-nature node out of which one state
of nature will occur
$0
Figure 3.3
© 2009 Prentice-Hall, Inc. 3 – 41
Thompson’s Complex Decision Tree
Using Sample Information
Thompson Lumber has two decisions two
make, with the second decision dependent
upon the outcome of the first
First, whether or not to conduct their own
marketing survey, at a cost of $10,000, to help
them decide which alternative to pursue (large,
small or no plant)
The survey does not provide perfect information
Then, to decide which type of plant to build
Note that the $10,000 cost was subtracted from
each of the first 10 branches. The, $190,000
payoff was originally $200,000 and the $-10,000
was originally $0.
© 2009 Prentice-Hall, Inc. 3 – 42
Thompson’s Complex Decision Tree
First Decision Second Decision Payoffs
Point Point
Favorable Market (0.78)
$190,000
nt 2 Unfavorable Market (0.22)
P la –$190,000
ge
Lar Favorable Market (0.78)
$90,000
Small
5) 3 Unfavorable Market (0.22)
0.4 Plant –$30,000
(
e y ts le
rv ul ab No Plant
Su Res vor –$10,000
a
1 Surv F Favorable Market (0.27)
e $190,000
y
Re y (
ve
e –$190,000
ga lts 5) g
Lar
tS
Plant –$30,000
M
ct
No Plant
du
–$10,000
n
Co
$106,400
ge
Lar $63,600 Favorable Market (0.78)
$90,000
Small
5) Unfavorable Market (0.22)
0.4 Plant –$30,000
(
e y ts le
v l No Plant
$49,200 ur su rab –$10,000
S Re vo
Su Fa –$87,400 Favorable Market (0.27)
rv $190,000
e
y
Re y (
ve
–$190,000
ga lts 5) rge
tS
$2,400
$2,400
La Favorable Market (0.27)
tiv Small $90,000
ke
Plant –$30,000
M
ct
No Plant
du
–$10,000
on
$49,200
C
Tails
(0.5)
1 (1 – p) Worst Outcome
ve
a ti Utility = 0
er n
Alt
Al
ter
na
ti v Figure 3.7
e2
Other Outcome
Utility = ?
Expected utility of alternative 2 = Expected
utility of alternative 1
Utility of other outcome = (p)(utility of
best outcome, which is 1)
+ (1 – p)(utility of the worst outcome,
which is 0) © 2009 Prentice-Hall, Inc. 3 – 57
Standard Gamble
You have a 50% chance of getting $0 and a 50%
chance of getting $50,000.
The EMV of this gamble is $25,000
What is the minimum guaranteed amount that you
will accept in order to walk away from this gamble?
Or, what is the minimum amount that will make you
indifferent between alternative 1 and alternative 2?
Suppose you are ready to accept a guaranteed
payoff of $15,000 to avoid the risk associated with
the gamble.
From a utility perspective (not EMV), the expected value
between $0 and $50,000 is only $15,000 and not $25,000
U($15,000) = U($0)x.5 + U($50,000)x.5 = 0x.5+1x.5=.5
(1 – p) = 0.20 $0
st in te U($0.00) = 0.0
e
Inv Esta
eal
R
Inv
es
t in
Ba
nk
$5,000
Figure 3.8
U($5,000) = p = .8
0.7 –
0.6 –
U ($3,000) = 0.50
Utility
0.5 –
0.4 –
0.3 –
0.2 –
0.1 – U ($0) = 0
| | | | | | | | | | |
$0 $1,000 $3,000 $5,000 $7,000 $10,000
Monetary Value
Figure 3.9
Risk
Avoider
e
nc
re
Utility
ffe
di
In
k
is
R
Risk
Seeker
Monetary Outcome
Figure 3.10
Tack Lands
1 ame Point Down (0.55)
t i ve the G –$10,000
er na ys
a
Alt rk Pl
Ma
Al
ter
na
tiv
e2
U (–$10,000) = 0.05
U ($0) = 0.15
U ($10,000) = 0.30
0.75 –
Utility
0.50 –
0.30 –
0.25 –
0.15 –
0.05 –
0 |– | | | |
Tack Lands
1 ame Point Down (0.55)
t i ve the G 0.05
er na ys
a
Alt rk Pl
Ma
Al
ter
na
tiv
e2
Don’t Play
0.15
Figure 3.13