Decision Theory

Instructions: Solve and answer the word problems using spreadsheets or excel following the different techniques in decision-making.

1. The market analyst of B-MEG feeds is asked to present an expansion of the company to the senior managers. The options are to construct a large plant, build a small plant, or do nothing. The expected payoff is determined depending on the decision on the market which may be favorable, average, or unfavorable to the business. If the decision is to construct a large plant, the company will gain 20,000 if the market turns out favorable, gain 12,000 if the market turns out to be average, and lose 18,000 if the market turns out to be unfavorable. In constructing a small plant, the company will gain 40,000 if the market is favorable and 20,000 if the market is average, and lose 30,000 if the market is unfavorable. If the decision is to do nothing, the company will gain nothing regardless if the market turnout.

The market analyst noted that the decision of each manager is affected by his/her personality. Each manager is described as follows:

Sylvia is optimistic

Vince is very pessimistic

Michelle thinks that there is a 60% chance that market is favorable.

Arnelle thinks that each type of market has an equal chance of occurring.

Edelyn does not want to regret making a wrong decision.

What will be the decision of each manager? How much gain or loss for the company will expect? Which alternative is most likely to be chosen by most of the managers? The figures are summarized in the table below.

Table of Payoff Summary

Expansion Plan Payoff Type of Market

(In thousand pesos) Favorable Average Unfavorable

Construct a large plant 20 12 -18

Construct a small plant 4020-30

Do nothing 0 0 0

Criterion of realism 60% = 0.60

2. The market analyst of B-MEG Feeds (Problem 1) has been able to determine further probability of occurrence of each type of market. The probability of occurrence is 15% that the market is favorable, 25% that the market is favorable, and 60% that the market is unfavorable. He also finds out that he can purchase the information on what type of market will really happen from the JBC Market Association at 8,000. What will be the decision of the market analyst? How much gain or loss will be expected for the company? Should the firm buy the perfect information? Why or why not? What is the best decision to minimize the opportunity loses? The summary of the payoffs is shown in the table below.

Table of Payoff Summary

Expansion Plan Payoff Type of Market

(In thousand pesos) Favorable Average Unfavorable

Construct a large plant 20 12 -18

Construct a small plant 40 20 -30

Do nothing 0 0 0

Probability 0.15 0.25 0.60

Criterion of realism 60% = 0.60