DE LA SALLE LIPA

COLLEGE OF BUSINESS, ECONOMICS, ACCOUNTANCY AND MANAGEMENT

Accountancy and Accounting Technology Department
Written Report on Quantitative Analysis
Leader: Leynes, Kathleen
Members: Cenidoza, Dominic Ian
Dy Bunting, Joanne
Espartero, Meriella
Mandap, Ernestine
Panopio, Jonah
Reyes, Alexa Jane
Soriano, Aldrich Mico

DECISION ANALYSIS
I. Decision Making Process

Decision making is the study of identifying and choosing alternatives based on the
values and preferences of the decision maker. (Harris (1980))

Making a decision implies that there are alternative choices to be considered, and in
such a case we want not only to identify as many of these alternatives as possible but to
choose the one that best fits with our goals, objectives, desires, values, and so on.

According to Baker et al. (2001), decision making should start with the identification of
the decision maker(s) and stakeholder(s) in the decision, reducing the possible
disagreement about problem definition, requirements, goals and criteria.

II. Steps in Decision Making

6 Steps in Decision Making

1. Clearly define the problem at hand.
2. List the possible alternatives.

3. Identify the possible outcomes or states of nature.

4. List the payoff (typically profit) of each combination of alternatives and outcomes.
5. Select one of the mathematical decision theory models.
6. Apply the model and make your decision.
Sample Case: Thompson Lumber Co.

Step 1: Defining the problem

The problem that John Thompson identifies is whether to expand his product line by
manufacturing and marketing a new product, backyard storage sheds.

Step 2: Listing Possible Alternatives

*Alternative - a course of action or a strategy that the decision maker can choose
Alternatives:

Construct a large new plant to manufacture the storage sheds

Construct a small plant

no plant at all

Step 3: Identify Possible Outcomes

Possible Outcomes:

Favorable Market (high demand for the product)

Unfavorable Market (low demand for the product)

Step 4: Listing Payoffs of Each Alternative

*Conditional Values - payoffs or profits of the outcomes

Because Thompson wants to maximize his profits, he can use profit to evaluate each
consequence.

Step 5: Selecting the Decision Theory Model

Depends on Decision Making Environment

Step 6: Applying the Model to make the Decision

III. Decision Theory

Decision Theory is an analytic and systematic approach to the study of

decision making.
It is a framework of logical and mathematical concepts, aimed at helping
managers in formulating rules that may lead to a most advantageous

course of action under the given circumstances.

Decision theory divides decisions into three classes:
(1) Decisions under certainty: where a manager has far too much information to
choose the best alternative.
(2) Decisions under conflict: where a manager has to anticipate moves and
counter-moves of one or more competitors.
(3) Decisions under uncertainty: where a manager has to dig-up a lot of data to
make sense of what is going on and what it is leading to.
IV. Decision Table
A. Definition
A decision table, also called as payoff table contains each possible event that can occur
for each alternative course of action and a value or payoff for each combination of an
event and course of action.
B. Use
It can be a useful way to represent and analyze a scenario where there is a range of
possible outcomes and a variety of possible responses. It simply illustrates all possible
profits/losses and as such is often used in decision making under uncertainty. In order to
evaluate the alternative courses of action for a complete set of events, you need to
develop a payoff table or construct a decision tree.
C. Example
Example 19.1 discusses a payoff table for a marketing manager trying to decide how to
market organic salad dressings. branches and nodes. Example 19.2 illustrates a
decision tree.

V. Types of Decision Making Environment

The types of decisions people make depend on how much knowledge or information they
have about the situation. There are three decision-making environments namely
o

DECISION MAKING UNDER CERTAINTY

Decision makers know with certainty the consequence of every
alternative or decision choice. Naturally, they will choose the alternative

that will maximize their well-being or will result in the best outcome.
DECISION MAKING UNDER UNCERTAINTY
There are several possible outcomes for each alternative, and the

decision maker does not know the probabilities of the various outcomes.
DECISION MAKING UNDER RISK
There are several possible outcomes for each alternative, and the
decision maker knows the probability of occurrence of each outcome.

VI. Decision Making under Uncertainty

A. Definition
When several states of nature exist and a manager cannot assess the outcome probability with
confidence or when there is no probable data available, the environment is called decision
making under uncertainty.
There are several criteria for making decisions under uncertainty
1
2
3

Maximax (optimistic)
Maximin (pessimistic)
Criterion of realism (Hurwicz)

4
5

Equally likely (Laplace)

Minimax regret

B. Use
The first four criteria can be computed directly from the decision table, whereas the minimax
regret criterion requires use of the opportunity loss table.
The presentation of the criteria for decision making under uncertainty is based on the
assumption that the payoff is something in which larger values are better and high values
are desirable.
For payoffs such as profit, total sales, total return on investment, and interest earned, the
best decision would be one that resulted in some type of maximum payoff.
However, there are situations in which lower payoff values (e.g., cost) are better, and these
payoffs would be minimized rather than maximized.
C. Process
1. Maximax
-Used to find the alternative that maximizes the maximum payoff
-Locate the maximum payoff for each alternative
-Select the alternative with the maximum number

2. Maximin
-Used to find the alternative that maximizes the minimum payoff
-Locate the minimum payoff for each alternative
-Select the alternative with the maximum number

3. Criterion of Realism (Hurwicz)

-A weighted average compromise between optimistic and pessimistic
Select a coefficient of realism
Coefficient is between 0 and 1
A value of 1 is 100% optimistic
Compute the weighted averages for each alternative
Select the alternative with the highest value
Weighted average = (maximum in row)
+ (1 )(minimum in row)

For the large plant alternative using = 0.8

(0.8)(200,000) + (1 0.8)(180,000) = 124,000

For the small plant alternative using = 0.8
(0.8)(100,000) + (1 0.8)(20,000) = 76,000

Equally likely (Laplace)

Considers all the payoffs for each alternative

Find the average payoff for each alternative

Select the alternative with the highest average

STATE OF NATURE

ALTERNATIVE
Construct a large
plant
Construct a small
plant
Do nothing

FAVORABLE

UNFAVORABLE

ROW

MARKET ($)

MARKET ($)

AVERAGE ($)

200,000

180,000

10,000

100,000

20,000

40,000

5. Minimax regret
Based on opportunity loss or regret, the difference between the optimal profit and actual payoff
for a decision

Create an opportunity loss table by determining the opportunity loss for not

choosing the best alternative

Opportunity loss is calculated by subtracting each payoff in the column from the

best payoff in the column

Find the maximum opportunity loss for each alternative and pick the alternative
with the minimum number

STATE OF NATURE
FAVORABLE MARKET ($)
UNFAVORABLE MARKET
STATE OF($)
NATURE
ALTERNATIVE
200,000 200,000

FAVORABLE
UNFAVORABLE MARKET ($)
0 (180,000)
MARKET ($)

200,000 a100,000
Construct
large

0 (20,000)

plant
200,000 0
Construct a small

00
100,000

20, 000

200,000

180,000

plant
Do nothing

STATE OF
NATURE

ALTERNATIVE

FAVORABLE

UNFAVORABLE

MAXIMUM IN A

MARKET ($)

MARKET ($)

ROW ($)

Construct a large
plant
Construct a small
plant
Do nothing

180,000

180,000

100,000

20,000

100,000

200,000

200,000

Sample Problem:

Use the decision table below to compute a choice using all the models

Criterion of realism =.6

State of Nature
Good

Average

Poor

Market

Market

Market

($)

($)

($)

Construct a large plant

75,000

25,000

-40,000

Construct a small plant

100,000

35,000

-60,000

Alternative

Do nothing

In-Class Example 1:
Minimax Regret Opportunity Loss Table

State of Nature

Alternative

Good
Market
($)

Construct a large
plant
Construct a small
plant
Do nothing

Averag

Poor

Mark

Market

et

($)

($)

25,000

10,000

100,00
0

35,000

40,00
0
60,00
0
0

Maximum Opp.
Loss

40, 000

60,000

100,000

In-Class Example 1: Equally Likely

State of Nature
Good

Average

Poor

Market

Market

Market

($)

($)

($)

Construct a large plant

25,000

8,333

-13,333

20,000

Construct a small plant

33,333

11,665

-20,000

25,000

Alternative

Do nothing
VII.

Avg

Decision Making under Risk

a

Definition

In decision making under risk, there are several possible outcomes for each alternative, and
the decision maker knows the probability of occurrence of each outcome. In decision making
under risk, the decision maker usually attempts to maximize his or her expected wellbeing.
Decision theory models for business problems in this environment typically employ two
equivalent criteria: maximization of expected monetary value and minimization of expected
opportunity loss.
b

Use

Risk implies a degree of uncertainty and an inability to fully control the outcomes or
consequences of such an action. Risk or the elimination of risk is an effort that managers
employ. However, in some instances the elimination of one risk may increase some other risks.
Effective handling of a risk requires its assessment and its subsequent impact on the decision
process.

Process

The decision making under risk process is as follows:

1. Use the information available to assign your beliefs (called subjective
probabilities) regarding each state of the nature.
2. Each action has a payoff associated with each of the states of nature.
3. Compute the expected monetary value for each action.
4. Execute the action which minimizes (or maximize) the expected
monetary value.
d

Sample Problems

We use the Thompson Lumber Company case as an example to illustrate

1. Suppose that John Thompson now believes that the probability of a
favorable market is exactly the same as the probability of an unfavorable
market; that is, each state of nature has a 0.50 probability.

2.

3. Computation for expected monetary value

EMV (alternative) =

P( )

Where:
= payoff for the alternative in state of nature
P( ) = probability of achieving payoff
= summation symbol

If expanded:

EMV (alternative i) =

(payoff of first state of nature) x (probability of first state of nature)

+ (payoff of second state of nature) x (probability of second state of nature)
+ + (payoff of last state of nature) x (probability of last state of nature)

EMV (large plant)

= (0.50)($200,000) + (0.50)($180,000) = $10,000

EMV (small plant)

= (0.50)($100,000) + (0.50)($20,000) = $40,000

EMV (do nothing)

= (0.50)($0) + (0.50)($0) = $0

The largest expected value ($40,000) results from the second alternative,
construct a small plant. Thus, Thompson should proceed with the project and put up a
small plant to manufacture storage sheds. The EMVs for the large plant and for doing
nothing are $10,000 and $0, respectively.

VIII.

Decision Trees

A Definition
Any problem that can be presented in a decision table can also be graphically
represented in a decision tree. A decision tree is a graphical representation of possible solutions
to a decision based on certain conditions. It is called a decision tree because it starts with a
single box (or root), which then branches off into a number of solutions, just like a tree.

B Use
A decision tree is most beneficial when a sequence of decisions must be made. It is
used to determine a course of action or show a statistical probability. Each branch of the
decision tree represents a possible decision, occurrence or reaction. The tree structured to
show how and why one choice may lead to the next.

C Composition
All decision trees contain the following:

A decision point or node from which one of several alternatives may be chosen.
A state-of-nature node out of which one state of nature will occur.

D Process
The following are the five steps of decision tree analysis:

1
2
3
4
5

Define the problem.

Structure or draw the decision tree.
Assign probabilities to the states of nature.
Estimate payoffs for each possible combination of alternatives and states of nature.
Solve the problem by computing expected monetary values (EMVs) for each state of
nature node.

In drawing the decision tree, we start from left to right. This makes the tree present the
decisions and outcomes in sequential order. The squares represent the decision nodes while
the circles represent state of nature nodes. The lines or branches connect the decision nodes
and the states of nature.

All possible outcomes and alternatives are included in their logical sequence. The user is
forced to examine all possible outcomes including unfavorable ones. He/she is also forced to
make decisions in a logical and sequential manner.

E Examples
Example #1 Thompson Lumber Company Case
The problem that John Thompson identifies is whether to expand his product line by
manufacturing and marketing a new product, backyard storage sheds. John decides that his
alternatives are to construct (1) a large new plant to manufacture the storage sheds, (2) a small

plant, or (3) no plant at all.

The decision table for the problem is as follows:

The decision tree for Thompsons Lumber Company problem will be:

Example #2: Thompsons Complex Decision Tree

Thompson Lumber has two decisions two make, with the second decision dependent upon the
outcome of the first

First, whether or not to conduct their own marketing survey, at a cost of $10,000,
to help them decide which alternative to pursue (large, small or no plant)
The survey does not provide perfect information
Then, to decide which type of plant to build
Note that the $10,000 cost was subtracted from each of the first 10
branches. The, $190,000 payoff was originally $200,000 and the $-10,000
was originally $0.

Solutions:
1.

Given favorable survey results

(market favorable for sheds),
EMV(node 2) = EMV(large plant | positive survey)
= (0.78)($190,000) + (0.22)($190,000) = $106,400
EMV(node 3) = EMV(small plant | positive survey)
= (0.78)($90,000) + (0.22)($30,000) = $63,600
EMV for no plant = $10,000

2.

Given negative survey results,

EMV(node 4) = EMV(large plant | negative survey)

= (0.27)($190,000) + (0.73)($190,000) = $87,400
EMV(node 5) = EMV(small plant | negative survey)
= (0.27)($90,000) + (0.73)($30,000) = $2,400
EMV for no plant = $10,000
3.

Compute the expected value of the market survey,

EMV(node 1) = EMV(conduct survey)
= (0.45)($106,400) + (0.55)($2,400)
= $47,880 + $1,320 = $49,200

4.

If the market survey is not conducted,

EMV(node 6) = EMV(large plant)
= (0.50)($200,000) + (0.50)($180,000) = $10,000
EMV(node 7) = EMV(small plant)
= (0.50)($100,000) + (0.50)($20,000) = $40,000
EMV for no plant = $0

5.

Best choice is to seek marketing information

We move back to the first decision node and choose the best alternative.
The expected monetary value of conducting the survey is $49,200, versus an
EMV of $40,000 for not conducting the study, so the best choice is to seek
marketing information. If the survey results are favorable, John should construct
a large plant; but if the research is negative, John should construct a small plant.

Here is the decision tree with EMVs shown:

Example #3: Marys Factory

Mary is a manager of a gadget factory. She is wondering whether or not it is a good idea
to expand her factory this year. The cost to expand her factory is $1.5M. If she does
nothing and the economy stays good and people continue to buy lots of gadgets, she
expects 3M revenue; while only 1M if the economy is bad.
If she expands the factory, she expects to receive $6M if the economy is good and $2M
if the economy is bad.

She also assumes that there is a 40% chance of good economy and 60% chance of bad
economy.

EMVexpand = [(0.4 x 6M) + (0.6 x 2M)] 1.5M = $2.1M

EMVnot expand = [(0.4 x 3M) + (0.6 x 1M)] = $1.8M
$2.1M > $1.8M, therefore, Mary should expand the factory.

Example #4: Joes Garage

Joes garage is considering hiring another mechanic. The mechanic would cost them an
additional $50,000/year in salary and benefits. If there are a lot of accidents in their place
this year, they anticipate making an additional $70,000 revenue. If there are few
accidents, they could lose $20,000 off of last years total net revenues. Because of the
ice on the roads, Joe thinks that there will be a 70% chance of more accidents and 30%
chance of fewer accidents. Assume that if he doesnt hire, he will have the same
revenue as last year.

EMV = [(0.7)(70,000) + (0.3)(-20,000)] 50,000 = -$7,000

Therefore, Joe should not hire the mechanic.

IX.Reference/s:
Quantitative Analysis for Management, Tenth Edition, by Render, Stair, and Hanna. Power Point
slides
Quantitative Analysis in Human Resources Research, by Wayne Stevenson
Project Analysis / Decision Making Presentation, Engineering 90, by Dr. Gregory Crawford

http://www.businessdictionary.com/definition/decision-theory.html
http://www.study.com/academy/lesson/what-is-a-decision-tree-examples-advantages-role-inmanagement.html