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Decision Analysis
Decision Analysis
When it is known for certain which of the possible future conditions will actually happen, the
decision is usually relatively straightforward: Simply choose the alternative that has the best
payoff under that state of nature. Although complete certainty is rare in such situations, this
kind of exercise provides some perspective on the analysis. Moreover, in some instances,
there may be an opportunity to consider allocation of funds to research efforts, which may
reduce or remove some of the uncertainty surrounding the states of nature.
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Problem# 2
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Problem# 3
Problem# 4
Problem#5
Kenneth Brown is the principal owner of Brown oil Inc. After quitting his university
teaching job, Ken has been able to increase his annual salary by a factor over 100. At the
present time, Ken is forced to consider purchasing some more equipment for Brown Oil
because of competition. Ken is planning to purchase one of the three equipment:
i. Sub 100: If there is a favorable market, he will realize a profit of $ 300,000 on one
hand, if the market is unfavorable; ken will suffer a loss of $ 200,000.
ii. Oiler J: If there is a favorable market, he will realize a profit of $250,000 on one
hand, if the market is unfavorable, Ken will suffer a loss of $ 100,000
iii. Texan: If there is a favorable market, he will realize a profit of $ 75,000 on one
hand, if the market is unfavorable; Ken will suffer a loss of $ 18,000.
1) Construct a decision Table
2) Construct Decision Tree
3) Which Equipment you will recommend to Ken to purchase under the following
criterion:a) Optimistic
b) Pessimistic
c) Minimax Regret
d) Equally Likely
4) If the probability of Favorable market is 0.35 which equipment will recommend to
Ken based in Expected Monetary Value Criteria.
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Model-A,d1
Model-B,d2
Model-C,d3
a)
b)
If the decision maker knows nothing about the probabilities of the four states, what is
the recommended decision using the minimax, maximax, Laplace, and minimax
regret approaches?
c)
Suppose that the decision maker has obtained the following probability estimates: P
(s1) = 0.6, P(S2) = 0.25, and P(s3) = 0.15. Use the expected value approach to
determine the optimal decision
d)
Determine the expected value of perfect information you can pay using the
expected payoff under certainty approach.
Question No#2
A financial advisor has recommended two possible mutual funds for investment: Investment
-A and Investment - B. The return will be achieved by each of these depends on whether the
economy is good, fair or bad: a payoff table has been constructed to illustrate the situation:
Investment-A
Investment-B
Probability
$ 8,000
$0
0.22
0.40
0.38
a)
If the decision maker now nothing about the probability of a three states of nature,
what is the recommended decision using the a) optimistic, b) pessimistic c) minimax
regret d) equally likely (Laplace)?
b)
c)
d)
Determine the expected value of perfect information you can using the expected
payoff under certainty approach.
e)
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