Problem No. 1 A. What is the maximax decision? Mr.

Frodo should start a very large independent gasoline station for it will give him the largest annual returns of 300 000 based on maximax criterion. B. What is the maximin decision? From the decision table, he should venture into a small independent gasoline station. Based on maximin criterion, this gives the least drawback of 10 000 when the market is poor. C. What is the equally likely decision? Station Size Small Medium Large Very Large Good 50 000 80 000 100 000 300 000 Fair 20 000 30 000 30 000 25 000 Bad -10 000 -20 000 -40 000 -160 000 Average 20 000 30 000 30 000 55 000

Based on the table shown above, in an equally likely decision, a very large gasoline station will give the highest annual rate average of 55 000. Thus, making this as the decision. D. What is the criterion of realism decision? Use value of 0.80. Weighted average = 0.8(best value in row) + (1-0.8)(worst value in row) Station Size Small Medium Large Very Large Good 50 000 80 000 100 000 300 000 Fair 20 000 30 000 30 000 25 000 Bad -10 000 -20 000 -40 000 -160 000 Criterion of Realism 38 000 60 000 72 000 208 000

Since there are 3 states of nature, consider only the best and worst payoffs. The table shown above directs the criterion of realism in each station size. Following the Hurwicz criterion, the criterion of realism decision is: Mr. Frodos gasoline station should be very large in size.

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E. Develop and opportunity loss table Select the highest payoff for each column or state of nature: Good market: 300,000 Fair market: 30,000 Poor market: -10,000 Then, subtract it to each payoff under each column to determine the regret value: Station Size Small Medium Large Very Large Good 250 000 220 000 200 000 0 Fair 10 000 0 0 5 000 Poor 0 10 000 30 000 150 000

Problem No. 2 Strategy 1 2 3 Favorable 10 000 8 000 0 Unfavorable -8 000 -4 000 0

A. What type of decision criteria or procedure should use? Which strategy would he use? Knowing harry as a risk taker, he would employ the decision criterion: optimistic or maximax. Then he would choose Strategy 1 (to invest in a fairly expensive microcomputer system with high-quality laser printer) for this gives the highest net profit in the next two years. B. Knowing Hermione, what type of decision criteria would she use? What decision would she make? On the other hand, since Hermione avoids risks she might use the pessimistic decision making criterion. She will choose the strategy with the lowest incurred loss, which is in this case Strategy 3 (do nothing).

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C. If Harry and Hermione were indifferent to risk, what type of decision criteria should they use? What would you recommend if this were the case? Strategy 1 2 3 Favorable 10 000 8 000 0 Unfavorable -8 000 -4 000 0 Average 1 000 2 000 0

If they were indifferent to risk, they should use the equally likely decision criteria. Indicated by the table above, Harry and Hermione should use strategy 2 to purchase a less expensive microcomputer system with high-quality laser printer.

Problem No. 3 Market Receptive 20 000 25 000 0.75 Market Unfavorable 6 000 3 000 0.25

Plan A Plan B Probability

A. Which plan would you recommend using the Expected Value criterion? Market Receptive 20 000 25 000 0.75 Market Unfavorable 6 000 3 000 0.25 EMV 16 500 19 500

Plan A Plan B Probability Calculation:

( (

)( )(

) )

( (

)( )(

) )

Employ Plan B. B. What is the expected value of perfect information? Calculation ( )( ) (

)(

Expected value of perfect information is 750. C. It is known from past experience that of all the cases when the market was receptive, a research company predicted it in 90 percent of the cases. In the other 10 percent, they predicted an unfavorable market. Also, of all cases when the market proved to be unfavorable, the research company predicted it correctly in 85 percent of all the cases.

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(In the other 15 percent, they predicted it incorrectly). Using the posterior probabilities, which plan would you recommend now? Market Receptive Market Unfavorable 20 000 6 000 25 000 3 000 (0.75)(0.90)+(0.25)(0.15) (0.25)(0.85)+(0.75)(0.10) = 0.7125 = 0.2875 EMV 15 975 18 675

Plan A Plan B Probability

Using the posterior probabilities indicated in the table, Plan B still has the highest payoff profit. Thus, Plan B is recommended. D. How much should one be willing to pay (maximum) for the research survey? Calculation ( )( ) ( )( )

Maximum payment for the research survey is 892.50.

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