Ch 7: Decision Analysis
Decisions under Certainty
Analytical Hierarchy Process (AHP):
Ali, a brilliant school boy, has received 3 academic scholarships from three
institutions: U of A, U of B and U of C. To select a university, Ali specifies two main
criteria: location and academic criteria. Being the excellent student he is, he judges
the academic reputation 83% and location 17%. The following table ranks the two
criteria for the three universities.
Percent Weight Estimates for
Criterion U of A U of B U of C
Location 12.9 27.7 59.4
Reputation 54.5 27.3 18.2
1) Summarize the AHP calculation.
2) Which university will be the best choice according to AHP calculation?
Decisions under Uncertainty
Decision Criteria
1) The Laplace Criterion
Step 1: Assign equal probabilities (1/n) to each payoff of a strategy
(having ‘n’ possible payoffs)
Step 2: Determine the expected payoff value for each alternative.
Step 3: Select that alternative which corresponds to maximum of the above
expected payoff.
2) The Maximin Criteria:
i. Determine the minimum assured payoff for each alternative.
ii. Choose the maximum from those minimum
3) The Maximax Criteria:
i. Determine the maximum assured payoff for each alternative.
ii. Choose the maximum from those maximum
4) Minimax Regret
i. Determine the maximum assured payoff for each alternative.
ii. Choose the minimum from those maximum
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Ch 7: Decision Analysis
Problems
1) The following table gives the details of a newsvendor’s purchase and demand
orders per day.
Papers 6 7 8 9 10
Ordered
6 30 30 30 30 30
7 10 35 35 35 35
8 -10 15 40 40 40
9 -30 -5 20 45 45
10 -50 -25 0 25 50
For the above criteria models, determine the newsvendors choice of
purchasing.
Decision Trees
1) An art dealer client is willing to buy the painting sunplant at $50000. The
dealer can buy the painting today for $40000 or can wait a day and buy
tomorrow for $30000. The dealer may wait also for one more day and the
painting for $26000. This is possible only when the painting is not sold. At the
end of the third day the painting will not be available for sale. Each day, there
is a 0.60 probability that the painting will be sold. What strategy maximizes
the dealer’s expected profit?
2) Oilco must determine whether or not to drill oil in the South China Sea. It costs
$ 100,000 and if oil found the value is estimated to be $600,000. At present,
Oil co believes there is a 45% chance that the field contains oil. Before drilling,
Oil co can hire for $10,000 a geologist to obtain more information about the
likelihood the field contains oil. There is 50% chances that geologist will issue
a favorable report. Given a favorable report, there is an 80% chance that the
field contains oil. Given unfavorable report, there is a 10% chance that the
field contains oil. Determine Oilco’s optimal course action. Also determine
EVSI and EVPI.
Decision Making with Normal Distribution:
1) A company is considering selling a new product. Each year, it costs $10,000 in
fixed costs to produce the product. Each unit of product is sold for $7 and
involves variable costs of $5.
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Ch 7: Decision Analysis
a) If the company sells the product in 100 stores and mean annual sales
per stores are N(52, 4), what is the optimal decision?
b) What is EVPI?
c) Now suppose that annual sales per store are N(μ, 9), when μ is unknown
and has a prior distribution given by N(52, 16). For a sample of 10
stores, average sales were 35 units per year. Now determine the
optimal decision.
2) Hole Cards Inc owns a chain of greeting cards store throughout the country.
The company is trying to determine whether a new card should be sold. The
monthly sales of the card is normally distributed with an unknown mean μ and
a variance σ2 = 100. Introducing a new card into each store will involve fixed
monthly cost of $57. Each card sells for 90c and carries a variable cost 30c.
What should Hole Cards do if it wants to maximize expected profit, if the prior
distribution for μ is N(100, 14.932)? Also calculate the EVPI?
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