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Homework 1 Sum04

Susan Solomon is considering starting an independent gasoline station and must choose between a small, medium, or large size. She developed a table showing the expected profits for each size under different future market conditions (good, fair, poor). The probabilities of each market condition occurring are estimated as 0.4, 0.3, and 0.3, respectively. Susan is deciding whether to hire a consulting company to research the future market conditions at a cost of $6,000. The consulting company's research is positive 80%, 50%, and 15% of the time for good, fair, and poor markets, respectively. Susan must decide whether to hire the consulting and which station size to choose.

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95 views1 page

Homework 1 Sum04

Susan Solomon is considering starting an independent gasoline station and must choose between a small, medium, or large size. She developed a table showing the expected profits for each size under different future market conditions (good, fair, poor). The probabilities of each market condition occurring are estimated as 0.4, 0.3, and 0.3, respectively. Susan is deciding whether to hire a consulting company to research the future market conditions at a cost of $6,000. The consulting company's research is positive 80%, 50%, and 15% of the time for good, fair, and poor markets, respectively. Susan must decide whether to hire the consulting and which station size to choose.

Uploaded by

dr.tamilselvan9157
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Homework for Decision-Making Tools

Problem 1
Even though independent gasoline stations have been having a difficult time in recently years, Susan
Solomon is thinking about starting her own independent gasoline station. Before starting construction,
Susan needs to determine the size of her gasoline station since the annual return will depend on both
the size of her station and a number of marketing factors related to the oil industry and demand for
gasoline. After some careful calculations, Susan developed the following table.

Future gasoline market


(states of nature)
Alternative Good Fair Poor Row Row Row Max
Max. Min. Ave. Regret
Small Station $40,000 $20,000 $-10,000
Medium Station $80,000 $35,000 $-20,000
Large Station $150,000 $25,000 $-140,000

1. Which alternative (size of the gasoline station) should Susan choose if the decision criterion is:
A maximax?
B maximin?
C equally likely?
D minimax regret?

2. After some discussion with her friends in oil industry, Susan estimates (subjectively) that the
probabilities of having a good market, fair market, and poor market are 0.4, 0.3, and 0.3,
respectively.
A. Determine the expected profit (EMV) for each decision alternative. Which alternative is the
best?
B. Compute the expected value of perfect information (EVPI).

Problem 2
For the above problem, Susan would like to consider the option of hiring a consulting company
before making her final decision. The consulting company offers to do some market research for
the future gasoline market at the cost of $6000. Since the consulting company has done similar
research before, it tells Susan that the research will be either positive or negative and historically
the research is positive 80%, 50%, and 15% of the time when the future market demand is good,
fair, and poor, respectively. So now Susan has two decisions to make: 1) whether to hire the
consulting company to have the market research done, and 2) the original capacity problem, i.e.,
whether to start a small, medium, or large size gasoline station.

1. Draw a decision tree taking into account both decisions that need to be made. Make sure to
include all probabilities for the states of nature, and the EMVs for each node
2. What should Susan do? (write down the course of action and expected payoff)
3. Assuming the decision is made to do the market research, has Susan paid the consulting
company too much or too little? What should be the fair value of the market research by the
consulting company?

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