r-.

' I N I'll I, I) I T ION

QUANTlc-rA'TIVE ANALYSIS R MANA EMENT

harles P Boni 11 i

Willilll,1 /1, Tilld.:en Professor of Mmt(/,~~lI]f'l1I Science Gradiuue SdllJol of Business

Stanford llniversnv

\-VUITCII II, Hausman

l'rofessor nf Industrial £"iihrPf'I'irlii mid H/l,~ll1eeri"8 Mnrj(jii"'''(,111 O"WlrI'''''11/ of industria! b'i/i"""nll~' 11/11/ Engineering M(""'l:f''''~1I1 SIIl'l/(II"(/ 11m w"il y

Harold Bierman, Jr.

NicIJ(l/II.\' Il. Nliy(~,r Professor ojllusiness /lrimilli,(lmliO/l Johnson Grruluate Schoo! 0/ MmwM/'IIII'lli

CD//ll'il I Inl Uf" HI v

'~ Irwin

!flfti McGraw"HiII

nO\! 011, M nxsuchuscns Burr Ridge, III i II(]i~ 011 buque, Iowa

Mad ison, Wisconsrn New Ynr k, New Yor k San l-rnncisro. Cnli fomia S I Lou 1\. M rssou r i

Moti va ti ng P:x ~ m pi c

Investment in <1 1VI11jor Transmission System

Ogler horpc Power COI'POl'.11 ill" (0 PC) is" rirrn in Georgia rhat gen~ri1[~$ and d isu'i hll~(:~ elecr rical power to COI1S-U mer- ow ned cooperut I VCS, I OpC lear ned thru the Florid" Power Corporat ion wa ntcd [0 purchase "ddil ioual power r rom Geurgi a. (florida i 111· ports a s1.gninci:lnl P['II'l of its power needs frorn Georgia. Alnbarna , arid SQUIll Carohna.) "-I'''n"",,,ion of the addi' iona I power \YO" Id require 1 he en nSI rue I ill" 01' n 500· k ilovoil I rans miss in" I inc. The in vcsrmcm "C, quir~d was M rhe ordc: of S 100 million, with prncnI i a I ~"ving$ (reven ues minus ell;'~) or nbou $ 20 mi II ion per )'eal,

The dec i sion fae i ng ope mnnagcrncru was whether Or not III construct I his ira nsm i,\\LUIl line: If so. whether Or not [0 II pgradc associated l rans rnissiun lacifiucs: and fin~lly. what fOI'ln of control over [he system 10 [lcg[) [ i a rc with F IOl'iri.ii Power. There WCI'C major U ncert ai ill ies associated \ v -i I h rhc j nvcs rmcn L r n pa rricu lar. [he cons truer i on C{J.K::;I, the com 1)(; l i [i vc .t;il. mH inn. in Flnrida , I he lo.ng- ru n power dcma nd in Florida, the silo rc of [hill derna or! [hill ope w""ld go'!. ilild Ii ~",II y, Ihe sprn price for power .111 ell" lei have ,'g" i f· Ie" III clf'cc IS <111 I he proli labll i I Y nf the vcnru I'C,

Man agcmcnl dec.dec 10 do H flll'mal dec", ion ann I· ys I, of 11m decision problem. An an,11 ysis tcarn. in-

4[)

eluding outside oI;..;)n.'U~lO'Inls.. worked with (OP rna nagcment 10 ucfi nc I toe problem using .1 n in A ucnce !ltag ram and then [0 dragram t he problem in 11 dec i· sion uec I"or mal. IJTObtlb il i tics for the. u ncertain vari a· hie, were obtained from g"'''rs within the fir rn 1101" had expert ;.E:,C i n I hose: areas.

An iI na 1 ySI S us i ng ex pee: led rnonerary value (EM V I rcvca led I he np: ima I dec i s ion, bUI i[ "1,0 showed 11l~1 there wa.1 suhsraru ial risk associated with II"" pol icy, fI" a nal y~I' cnlcul ill ing the va I LOC 01' in fGr· mill ion ubou I I ne "'"jnl' unccrtaint ics revca led thi11 oil, lain; Ilg i nfor nuu ion IIb"LlI I h c compel i Live si ,,,"1 ion before making 111C <Icc ision cou Id hu vc a hi g i m pac I. and rhe Ii rrn undertook n study 10 do III is. T he a ria I y. sis led IQ a .,mllcgy I hnt <;u bsranr ia II Y red uced 1 he risk for [he optimal [MV policy.

Tile analysis was done in a two-week period and identified a strategy quire different rOO III , arul sigrnficaruly beucr than. that which would have been underrakcn wi[110LIl the SL\Rly_

IT hi:>: I~ luucd on Adum BI,lJI:-.CHl, "Oglel hnrnc POW-c.1 Corprua: 1011 f)L"::Cldc.s nbcur ] 11 VeSL mg III n Mj1t(jl' THlll:'iU11:--;:\IWI .~y"~1c..:I'n, ,. '1IleII{jir,~ 25, rlO 2: r M4m.:b,~A pnl I')~.s), I'P, 2$··,)6

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CHAPTER

6

-- ------- --- .-----.---,-~--

DECISION MAl<ING UNDER UNCERTAINTY

I co I h i -; cha p ICI" we consider the a ppl i ca I i 011 of proba b iii ty co ncepts to bus i ness dec isions Lhal rnus: be made under condirions of unccrtairuy, We shall develop a means for rnak i ng consistent decisions and lor e<:1 i rna: ing the cosi 01 uncertainty. We shall initially propose expected monetary value as an appropriate cr iterion for decision making. Later in [he cha pier. we will desc ri be I he lim ita lions of expected moneta ry va lue ~ nd s uggest mod i fications in I he a na I ys is.

We will also introduce the opportunity 10 experiment: (hal is. 10 gather addiI ion al in For IlUI ion and rcvi sc proba bi I i I les bcf ore m a king I he dec ision

Conditional Value

TAn!.I' Ii-I Histnrical Demand

Suppose a groccr is faced wi th a problem of how many cases of mil k 10 stoc k 10 meet tomorrow's demand, Assume (hal any milk thai rCITIDins unsold at the end of the day will represent a complete loss 10 (he gmcer, Also, any unsatisfied demand bears "0 cos I except the CO.II of the los [ sale: (he disappoi rued CLl~ Lamer wi II come hack in the future, This example is highly simplified bill illustrates (he basic principies of condi I ional 0 nd expected value.

In ou r anal ysis of I he groce', probl em, i I wo uld be hel pful if we k ne w sorneI h ing abou I pAS I sa I es, on I he assu rn pi i on 111,11 I h is ex periencc m fly ser vc as a gu ide LO what may he expected in the fuiurc. Suppose Ihe grocer has maintained records such as (hose shown in Table Ii-I.

TC)f{lf Delll(Jnd jH:r'Day

Nrllllbt:"1" n/ DrlYs ~m:h DcmrJnn L(:V1!f Was R eC()I"(/ ed

1jrob{1()Uil:; of ~(rdl el)C'11i

25 cases ~(i cases 27 cases. 28 cases

0,10 o.ro 0.50 0.10

100

20 IiO 100 20

2011

~41

242

\.V,1I1 a purchase price (variable cost) of $R pel' case and iI selling price or $10 pCI' case, the rahlc of conditional values (Table 6-2) IS II dcscripuon or {he problem Jucing tile gro icr. The possible acuons (number of' cases to buy) ['lIcing the grocer ure 11.'\Cc! [1CroSS the tOP or the ruble. lt is, of course, possible to buy 2'1 or 29 cases, and so <In. but ,f', in the last 200 days, sales were III the runge of 2'i-2H cases. the grocer mighl View il stock of gre.a(er than 28 or less than 2.' as h avmg zero prohabiluy or occurring. We shall make this ussumpuon The possible (conceivable) cvcnl.,-in this example, the possible sales-c-are listed in the far ler, column If the grocer is willing to assign prohabiliries in accordance with the historical data . then events (sale,) other than those listed will carry zero probahiliucs ; they :JI"C considered impossible events

Tallie 6-2 can be thought or as a conditional value or conditional profit rablc.

Corresponding to each action the grocer takes. and each event that happens, there i., a given conditione) profu. These profits arc conditional in ihe .'~MiC tlHI 11 certain profit results from following H specific course of acilo» (act) and having (I spe ific demand (event) OCCIil', A II {he possible combinations arc shown in Table 6-2. For example, If 26 cases were stocked and the demand turned out 10 be 2.'; cases. the grocer wnuld have iI profu of $42 (thut 1.\. 2S I [) - 2(, , g), The best <lei I' Dr each possible evcru is indicated by an asterisk

I""oking nr the act column "Stock 27." lei m; Ir;ICC {Ilrough [he calculations nf each dollar amount. This IS done III Table 6-3, Similar cornpuuuions have w be made for :Ie" "Strick 2S," "Srock 26.'" and "Stock 28,"

The cntculmions of Tahlc 6-3 reflcc: (he faci rha: if 27 cases Me stocked, only 27 CHn he sold. even i! tile dernund turns out to he 28 CilSCS, Hence. [he pro Ii I reaches

TARLE 6-2 .onditional Values

PII\',fiblt: Af'I IfIl I I'
------
,1'lm, Stoc« S1(P(k, _\'tm"1:;
E'"ol'rrr' nt!iJtlJJfd /5 26 27 18
2j C~.bt~~ ~_\Il" $'" 51" ~l(,
:!() C~~.~t·'" )0 52- "./·1 )(,
:n t;4'1,~C~ <;0 5, 54 ' 40
2R. C'~5:(~~ so 52 _ilt 5(j I L';

I.

II maximum of $54 for the sale or 27 unus and levels off at Ih<l\ ligure even if 2~ lInils arc demanded,

The Loss Table

III addition to making ~I table shewing condu innal prOrll_, ITable 6-2), il is possible to construct a table showing conditional opportunis» /().<Sps (Table 6-4)_ Consider the act "Srock 28," If the demand turns out In he 2R, the g.rocer will make a profit of $56, This is the best Ihill C8n be achieved with a demand of 28. Wilh 11 demand of 28, if I he grocer had stocked on I y 27, the profit wou ILl have been S5 ~: t his act would enrai) a $2 opportunit v loss compared with the bes: net ion wub a demand of 28, If the demand were 2S and 111e grocer 'locked 26, I here would be a $4 conditional opportunity loss ($56 - $52). Opportunity loss CHn be defined 111 general as the ClmOllllf oj profit [orgone hy II0t /'IlOil,nll/: the /}I.',~I lICI for earl! event. With this definition, the cnnduional opportunity loss wble shown in Table 6--'1 can be constructed.

II should be emphasized that acnnduional profu (or loss) rel"le, to a profit con-

ditional 011 both:

I. A rt event happening. 2.. A given action.

We do nOI know which event is going [0 occur: {here i~ uncerrai ruy. Therefore. rhe condii ional profit ror a decision is nOI one number hut a table of profits (or losses) associated with possible events. Profit i., ~4~ only on condition of both stnck- 111£ 27 units and having an actual demand of 26 units, If the dernand rs different than 2fi units. the actual profh will be different Ii1Hn $~4,

TAlILE 6--4 Conditional Opportunity Losses

SrM::k 27

Srock 28

510ek 13

25 C4lSc.s 26 L:'ISe~ 27 cases 28 c.'e,

so ,

S~ I) 2

Cnmpuunlcns or CUluJiliOlliil Opportunity Losses

TI\III,lo Ii-J O{;/lfIIUrli
Condl I tonal ('n,H (Jf 'J7 Carulu;ftlutl t\(I [0'- {'mjilof f)fffl.'r~fl(.j' IU!f\l't!('Ij fmfit of 0pllmum Act (W~/lh(.' Ac/ 0/ Srn(klll~
,')"'!lIII,(: '{;Hul Cuscs Pro/it of Ar.( EW11Il: Ent:h 0pl/llli1111
(' r olits of Act f:.."(.'lit, f)cHfmrcf Puce !(CI'l'UW' (17, $81 "S{O(~~ 27" O(!tII(Jlld EVf1M Acl Slnek 25 Sioc« 2fl Stoc« 27 S",t'! 18
"SlOel\ 27"
15- C;!~.c~ ~ 10 $2_\(1 5216 ~34 25 25 $50 SSt) - $50 = SII SSO t4l = ~8 $.10 - £J4 ~ ~ t 6 ~SO - $26 ; $2~
26 CllS!::'. In 160 216 d~1 26 2() 52 52 50 • 1 52 12~ 0 52 -, a. = ~ 51 - 36 ~ 16
nC<lse;;.; tn no 210 _\~ 27 27 ,.1 S4 50 • ~ ,4 j2 ~ 54 - 'i. ~ 0 511 - 46 = ~
28 C'l:;'e.S to )10 216 54 2~ 23 51i So 50 - I> \0 )2~ J 56 - S4 ~ 56 S6 ~ 0 2.J.1

Evel1 111 n 1I ~h ihe ("'11(1. 11011" I 1'11111<" ,111(1 lo,s~, he I p ['I ,:11':1(' I'~I'III~ III,~ pi 1'111 lc 111 filei ng the grnecr, II " 1,.,1 WI I,,,,,,hl<' Ir> nl lc: an opu 11111 III ~I)IIIIIIIII I h .. ~"'n'l could chouse II,c h"" ,'lI ,,1111 ", lv, IIlLO , k now ledge of 11>11I"H"" \ dCII]'1 n<l hili I II" uiforrnanon I~ nrn "vm!.,hle III uui example. The problem t"'lIlt the ,'.rnec, "In a"~<1gn prohahihtrcs In IIw 1"",,[,1,' CI'CIHI and then ([\ analyze Ib,' <1,:11"" 1,11~''''''!tVC' If Ih~ probabiluics il .c h",,'<1 I II' III' 1m ICHI • 11 fOlrma I ion (sec '1 able (, I), II ICY IV i II be as shown in Table f1 'i, II IIIL' g"IIen helicvcs thai fm sruue 1'[';1.''''1 101l1~1 row's demand will I',) ry some wh.n I" lin III r !lIN'1 vcd paucr n, I he prrlh:lhllll)' :I""):1111IC' II shou Id be modified

The "e~1 <IC[lI~ I" III In" I hc ,H'~lgned prohabrhnex nun 111,' all,11 )"" We accornr"'h Ih" b)' '''''"~I"m,, 1/),' "101'/'"''''''/ ""/Ul!.r {Of ract, CI'f'IIIII1 lilt <,o""i"",,,,/ V(J/IIL' tobl» bv th« I'm/,"/,dlll "I IIII' {'L','I" ",.n" , "',~, lilli/ ",M,,,,~ till' l"rI;/,.,.I' The I ""llllIllg 1111 Inlll'l "II,I' I'S jll'L'IP,1 mnnctar-y \'>1.111,: I'm 111': 11('1. III~ L1plllllllill :OCI i, the one with rhc 111):1,..'1 nl"'~I"" mnncmry ,"111(', TIlL' .. "kuIIIIIlH" :II'~ !:ivcl1 ill -C,hlc 6- (, 1'111 111<' ,In, III '"IL'klll~ lr. .md 27 unils llu, [',dL 111:01 """ fill 2S and 28 unus wou 1<.1 he "01111;"

I n Table 0-6, 11lL' c~l'ecI~d lIumerar) value (E.'vI V) I~ ~ah 1I1,'/('d hv muh Iplylng each condurnna I ";11111' IlY I!~ pi L '~,It>illl\' and the n <I(ld, n)! 111,' wClgh red ~(llfdi I innal values. Table (1 1 ,11(1""" 111(' <·~P"l'I.,cI monetary val lies ['("II "II I""r JCI~, I'N the act ,. S Inc k 26," I he l'rn~c'r cnlcu I" I (', an ex peeled 111<111<"" I Y v: I It re 01' $ ~ I. I he h ighcsi EM V. Therefore .. 11:".,01 00 "~IWCICd rnouerar y value. 26 (."ilO(', ~I"'uld he 'Inlkcd,

.'iDle ih.n rhe I ,\lV 1)1 'j.~ I Will 1101 be rhc 1" "Iii 'm ""Y nil\' rj;,y II IS the expected or aver ;I):C pI! >111 II Ill,' d,'to "on were repc,liL'd lUI /II;rIlY day' (with 1 he same pr(l"~",IIIIC'). rh .. 1!"l{"1 1",,,,1<1 make an avcruue nl ',,_~ I rer dlly h) stocking

I

1:\ raee-, ~f; (,1:I"i.('"" 17 case'2~ case-,

n III U "UI I) .... ~I IIIII

1011

f,
TA,IIII', (, (,
<.",,11'111,<111111' IIr 'h'1 ,\"or~ 2'6 Arl ~'t1I ~ '7 J
"
E.~P'·l'I!'.1 ( wr,I'lllljrt~' ("11 "ti.("l~fll€'d ('IIIJr/Himr(r/ Ct' W",,~I"'.'" ,<0
IVlollU'IIII''v \'nllll',~ iol'l'lrr. Ilril/}.l1lj/lll' l1l'r,/' f) 'I' ,lr'fl/l{J(rl'rfl' Vir/tl/I In' /Jmbol,i/lil !
, )~'II~ljlld It) J;l"'111 1('10') of '.':~·f'ru 1('11) rl/'·,:I't'111 I
i ~ (".j: u ...c:. 01(1 ~,12 ~ 421l HI ~ ,1M) t
16 cuscs 030 ~~ l:\foCl ',I 13m
n [il:!-.~'i 'I,n ~! 261"1(1 ~'I ~71l(l ,.)
!~ L,:iHCS. n III It 510 \,' j 40 J
1(10 "I
8'
I :,x per-ted 11101H~ljjl Y lin luc ~'; I 00 ~.q Oil ( T,Wl.lc (,-7 SlIIllllU\<'Y"1' E~pt"'lrd

MOHrt" r)' V" I ur~

J',I/Wl.'tt1tIVlmll'/(l1 I'

'\I'r Vlj'rjt'

L.;.IIIL ~ J ~

"IIH ~ '~1 ~I<d ~7 \IU{ ~ ~~

\,11

~ I ~l1pH"WI1l ;tCI J l'~

I:

1(, ,'a,c' "I milk. F.vCIl if the <Ieei"IH1IVcr~ "OIICP~"I~(1. the aciinn wirh ilu: hi):11CSI 1-. M V " 111,' h~'1 JllCr nal i ve ! hal Ih" dn","" 11I,lke, has a vailable,

1;, vu 111111" n zc, ou 1 pia n for sol VIIl~ the I' 1 {,,",,'I \ prnbtcm .s a< rollo" <

I {11""I1~1 " pnyoff (condn.onnl valil~J tuhle 1"'"'1l rhc ~C!< "ntl ""t'llI~ 111,11 urc ,', III," Ilerell 10 be pO,~1 h, III i C'" ,IIi( I I !'llIlg I he 11111 comes 1"01' each uc l <lIHI '~WIlI, III liSiIng the events. he qll"(' 111:11 ~~I('h ~V\:"I is mutually .,,~{'lil,ivc

(, " , 11111 ke ,111'~ I hal no I w" nr 111< \1 C t, vc Ill' ~'d n ncco r si 1l1ll1IHIlCOI', I y) .uul 111,11 'III 1'~CI1l~ considered I"g~ I h~1 i1r~' ,'\ Ilau~I' Ill' (I C • I hal II", f·,'r,,1 ~ I" leol c I ,,'CI ;111 I he possihiht ics] Thi« 1,lhle i "dude<' I he econorrncx of II,,' I" ohlem ('llI I', revenues. and prolns) b) 1"""'111 "I): ~ {nnd IIIO(la I value I Of I,,~,' 1111 ll.t,t h LlI..:I and event cornhmauon

A"'gll prnbnbiluies In 111e cvent-,

1, Culculaic un I,MV for each :I~I hy w('I~hlll1~ 111111lliplyingl the cunclu iMnl L'CI I" c, hy I he ""i gned probahu i ue \ ,11111 ;Idd Illg I he we i gill cd cuud i, I" 111111 ,;IIIIC, 10 obuun Ihe EMV nf rhc ,I"

~ ClI"n'~ I he act wuh ihc la rl!<!~1 I VI V

Expected Opportunny Loss

'IA.II1,IO fi-R Culculat inn or EXlwclerl Oppnrilln.ity 1,1l,,1C,,

The gn)('ci can also choose (he best II{'"' hy 11111111111/.ng ("I'~ctcd "1'1,,"'1 u nlty Ins, I EO!.). I hc procedure ,~ the same ;I, JII" ""t II ned except that In"ead uf U~I"I' the rilyoll table [condi II"" al value urhlc. Lohl,· II 21 and condrunnal proms. we ,1).111 I"~ [1[(', coudumnal {1pporlunlt)' lo~, \ahle ( lnhle fl-t1! ~rld coridiuonal oppru ru nhy In.;,,:, 111~ rnlcularions for "CI "Sind 2"" II 11 el ~~I "Stock 27'" arc fl< l~iVL'1I III To1hlc (, H

/',\'.'11/ JJI'IIJOIJI/

C"mftllfllljrJ '.t,\,t~,l icu

n W"~""'1i (-t)II(lj,wtrnl ( v IV"JI:ill""
In "ltt/~tl'~I'ih '.tl.n't,1 h,· Jt1lliitliJlJII v
Ilf J'\'/"II tct: f~/l;n'lll
----
'\11 ~II 516 SI (,II
IIIWI S 110
I lin 0 <11K)
11111 0,0
'i/.JIi '" en JlrjIJltl/u/rl\ {II' r:1'~ltl

~.l t:.I~>I,.·'" ~'I .; ... C' 21 'CI-t .. e 28 CL'~t ...

1\ 10 010 If ~O 0,10

100 L\~IlC".rLCcl n-~)rUlll~ll1Hy ro~ ...

2<1(. flu I II lJl'(',,,,,,I,I!ltl/lll\
11\111" 6-9
SHlnlllul')' ,II" r tl1r,/Ullj\tI'/ III
I: ~,w(Nd 011,WfHmtll' '.1/11'j'jt·d ('/JIUH'/lrJrlf\1
h'IH'l'lpd A~ r /,,,1,,, I "\'r~ \1'/1/1 0,,//"',111'1
()pll(\llunj(~ ~IO\ I • .!5- I'll ~I
~ .o "~t.l!.,
S,141t.k 2(, , ro (i1pllllwm rlCl. "
"'UtI.,. ~7 l'l)
\Uli.J: ::!X II I ~ l-rorn Tahle II <), we find .il;1I .11(' glncer '11IH11<1 "hom ... net "Stock 2( i," wlucb ha~ an cxpcrml III~' "r $2.20 .• he IllIv,'~1 of rhe 1'11'" 1'~III'('lcd OPPOI"IIIIIl')' I",scs.

S 11111111<1 r

1.,'1 lIS ~llll1ll1all/" III,' various 111('''''"~' (11 I'lOfilllhlh.y Ihlll have been 1111,,"I1,cc(1, Condniunnl valur Tile actual prntu that would n"1111 Iollowing il P'Vl'lI 11(:111111. condruonal <>1' J !!"cn event ')(:llllllnl;.

ConrilflO/url "JiIHJ/"/lInin' loss. I Ill' 1~I"LL"c IO.IS \1 I' .. II,~ profit nlll c:lrllcdl '"olloWlll~ II ~iV"1I action, concli. iOlla' un il ~iVl'11 1'\-'l'1I1 occurring F.X{'l'<'il"{llIfoll,·/m v value I he cundmonal valucv \\c,!.duct! hy I Ill' pr"h,'hilll~ 01 the cvcut- 1I('U" 11I1?,. l1nd '1111111H.'d tor cnch an

/·'p,.,'r,'d "1'/"'l"frllll'" loss 1111' rondirional nppllrllll1l1y losses Wl'll-\lIh'd l1y ihc i'lohahllu} III Ihe evcm-, IInUI IIII~ anti wllImnt for ~,I<.h aCI

The npuuuu II nc: is I h e net W II Ii ihc grcarcs I C x pt'C I ~II III"nela 1')' v;IIII", :n1(1 I hus, (ill' '"wll~.Sl C~jll'lll'd opponuuuy 1".,\

Ri: 1< III Deci. ion .Ylaking

:1

A lthough expected monetary value IIl;1y be a good gllld~ 10 action m many Cf'~~S, it 11I:Iy 1I0l be III nlllt'ls This doc, nOI destroy the e~p(,clcrl value model; II IIIC'''IS we 01"', modif~ • Ill' an"ly,i, when rhc suuauon V .• trldlll~ II I CI us consrdcr a major IbftlCUlty wuh CXrl!ClIo!U moncr.u y value

Suppose II I 11111 I:lgel has n Ci1II1ICl' III invest S;'iOO.OO() III n speculuuvc new prodIII t Assume Ih"l II urc product " succc-sfu]. there !VIII he net prolil\ 01 ~ I nullrcn However. If I he product I, UOI ,",~e"!u I, I here Will he ,I 10-'-' of I he 'f,~on.oll{) 'pent 10 develop, I'r\lrlll~t'. 1111(1 sell the III'W pi od\ICI. 0111' 1I11I11I1!\CI"~ condu iuual vuluc iabtc " gil'en rn Tallie Ii I ()

If. after gillhl'llUJ' evidence. Ihl' Il101l1ager as\lgns.1 \lIhJCCII\"C proh.lllIlll)· .. r 090 01 success, 111~ LMV nf the aCI "Invest" would he $lti(),OO(] (SI.OOO,OOO X (J,<)O - ~~OO.OOO x () 10 SH50,nOO). II, compared with an liMV of zero fm llil' "C' "Do not mvesi .. Suppose. however. rhru the finn is In .. wly difficult tinanciul pO"IIOO. nrul a $S(J(),o(Xl Ill" would leSlil. III certain bankruptcy, In such" CAse, I',MV may Ill' u poor gil i d,~ III lit; IIn~. The 111 ,lllIIl~CI' III 3 Y he II "willing 10 accept JI (] 1(1 prohabil-

I,

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I Alii I (o-!O

r 'orulltlunnl Vuhll'

241

'·l!.tiJu'-.( wC(;e'- [ul 1)II)dm I I'ill ~Llnl',~hil

~I llOO.cxX! <lIn.mo

I II

ily of losing ~5(l(l.!11)1l ""g~rdlcl~ of the "lC of 111C ,nllllillnilill prouts 111' I he l:MV. because of the undcsrrable consequences of the 10\, It \0. the manager I .. " ,1 b~ge divuuliry for Slldl " In,s. andthrs IhOl,!d be b[nuglll If1IO the al1.lly"., I h[l( I~, in "'lllIlions Ihili rnvolvcn substanu.rl IIIIH'IIIII of nsk , I' MY may nOI he llil' iWsl deervron crucnun

II I he .1 1Il0i101' III money IIw"I\,!'" 111 I he pi' YIlIl Me not I~ rgc, Ilw II F M V IS " ICIISlJrlnbl~ gilide HI .11:lilll1 Such I, 11i~ cllse or 11m gllH'(:I'~ problem "how "Lnrge " Il1lhi, eOIlI~XI. ", III 1'''lJr~e. rclnuw IkCI~lOn~ lIl\'olvlIl~ 111111,011\ of d"lla" 111~) no. I", large for .1 m.uor "il <:(11111'''11) III a Wall Street <:urreney trader hili lellarnl) wOlild he fOi mil'l Individual" Whcthc: II par uculru ilell,ICJO ,eCIl1' r"hy ,,1,0 de[11~l1d~ on IIldil'ldlWI prcf'crcnccv S'HIlC individuals 1111' 11""" risk (11'1'111', anti Inigh. he unwilling In rake even moderate f"h. while olher~ may be risk ncutnt! (in<.lifTer· em (0 risk), or even Ink IJre/amlg, There MC [nr rrtu] rncthrxls for mcorporuung ris~ into rhe decision (1IIIlIy," cHlled utl Iii)' theory, TI1I~ IS C\lV~1 ed in rile dcmll III R later chupter.

!oven \\I1"I1.h,· ,kcl~lOn inH.lw.s substanlla' nsk . .he .. alculauun ,llId Cv"IU311no IIi' rhe expected mnnctary valur ('1111 provide usciu: mlorruuuon I'm IIII' dc,,~i()n mukcr. The <11'('1,,""1 maker (nced Willi ihe lIlaJ'" 1'''1<'1111,,1 III'S 111 rile C\lIll1ple of lahle 0-10 knnw, lrom the I \I1Y .. alculauon 111." the 10oe'lml'U\" worth" :hH~f1.000, TIll: tIC~I\II>n maker k,IIlW, how much lie !II sill' IS glvin~ lip In "",,,(1 rhe 1""slhk 10, .. Altcrutuivcly, he 111' -hc muy be ~hlt· In lintl II partner \VIIIIII!' 10 share III the venture •• h" could ~lIb'(;IIIII'IIl)' reduce ihc dnwnsrdc rrsk

Exp ected Profit with Perfect Predictinns

Rcruming III 'Jill cxurnple of the gruccr, lei U" raise II,e I"ollowing quest lun : "What profil could the 1lr<1I'~1 Hf'CCI In make ill 'he future If each day's rlernund could he predicted will" rruunt» rhe day before the particular dcrn .. nd occurred I' rn answer IllIS qucsucn. It'l I" construct :I condhlona: value lahll' 111111 will show the ,'<llld,I,O al [lwlil for rnc />,'SI 01"1, glvcn e.u h rveru Table 6 II I~ cnustructed l1y 1'I1I1I)~lng the hes! act and rCrflldlllj.' I he hlghc\. proll1 hgurcs im citdl event (Ihl' 1II11I11II,llIlIn can he obtained 111l1l1 1,II1k (, 2) 1"111 exnmplc, II wc knew uunor row'x deill" ncl \""",111 he 27. we wnulr] "I'I'k 27 cases. 1',,, II pm!il nf $,'111 II WL' stnckud 2(" WI' wl)uld forgo the '!-2 prom nil nne 111111. and ,f we stocked 28. we wuuld h.rvc co scrap onv 111111 ;,( a Inss or S8. Tahl!' (, I! ,how< the prolll resulting I rom the h"<1 acuon 1m .nch possible even'

Lei us e0l1Wl1 rhcse condinnnnl optimal 1'10111 "gille, [0 an expccu.non This cun be done hy \l.·clghllll!.\ the fllurU for each even! tay I he prnbabiluy III' the even! occurring. The calculauon is shewn 111 Table 1i-12, where the cxpccterl I}Fofi1 with

'I'~III I', (,-11 t',ull,lili,mul Va 1m' IlIhI!' fur Oplimal 1J,'l'i ,j nns wi III 1'('I'1'l'<;( I'r'cdiCli'''1

L\IIU, ( ... 12 l\~pI'~lcrl Profit wlrh I'cl'ih'l j'I'I'<iidiu"

Expected

A~ I

J \ CiIH''l, ~~(I

"11 '_'ll:"C"i

]1 C.jJ' .... cs

':iC II.":,]"'L:'~

~'il

Pm/milt/ril' COlttllrlfllltl1
JI't"H 1)~lljjtjjlr' II I I: I'~ I I j r "IO(JI ({'PI
l~ ,a~c~ 0111 $';10
~'l ":1J~t:.:'o 11111 'i'
17 (;II:-.U~ II.~II ,\,1
2M I.:"' .... c:~ 11111 \1' l JJ W .. r~lj't"rl JI~' "'fli}fJ'Jrit/.I' o/I':lllI,jt

I· \pecu~d pmtu ",..., 1111 1:IoCi f~'1 l'ICdlct.OIl

, 100 I ) (,0 lI.UII 1M

1nZIl

tJt'rrt'CI prediction (,"5,1 20) " the prulu III<' grocer cnu lei make nn the average If e.rch day's demand cnuhl toe predicted HI ,ltiv,lm:c, Thus. rhe ('1'1111111111 amount would be (II ucrcd each day,

IJ,j",.e the pel f"~1 I" nlj~lm i, uscd , the grocer i, sull unccruun .1\ 10 wluu the pi "IIiel inn will he, vmre .my nne nf Ih~ fnu I I'VC "I~ may occur Iit-Inre the prediction. the pmli! 1S an l'AI"'I"nl111l1, smcc we dll ""I know which evelll will occur, To <let III" whet her or nOI 10 1111' 111(' Iwecl i elm, ruu t'. rocer musi ass i 1\11 1\ vnlue In I he pcrf'cc I pi '" her ion and compare 1111 ~ val UC \Villi 1111' W~I or the prcd it, tor. l(crIlclniler 111,,1 belore huy i ng Ihe III rll III Inl inn, we llo 11<>1 k 1111'" wruu tbe prcdicrinn wII) be,

alue of Perfect In formation

I" 'l1~ny decision ]lrllhl1.'1I1~, the manager i'IlCC~ the quest ion oj' whether 10 act irnJIIclI .. llel)" 01' delay acuon and seck 1l1'''l' uununa: ion, The uuponum thing In 1111' m,lIl,lller IS 10 balance IIII' rost of addu I",wl iulnr mauon "galll'l til<' 'm/"e (addumnal fll oli I) n! I h c in IN 111.111"11, The cn~1 1''' II 01 1111' decis Inll (~O,! 01 "hl,LIIII ng infnr ru.:

IILIIII 1'< usually (:n~"'1 10 cnlculare 1111111 rhe VIIII"~ 111' the mfurumunn. l lnwcver, \I"il'l:

II,., expccicd value II"Hlcl, we have ;1 W.IY "I qllnmifyiliA [II!' \,:lIII~ of o1delil innul mfunu.urnn

Hdel'l'ing [igilill II! uru grocer cxumple, we showed III '['dLI(' II 12 tha: the ex- 1"'(~lcd prolir willll'~II~~1 prcdrcriuu j, ~~,l,20, l'rcviously, III TiLI'I!! (, 7, we ,lhnw,1(1 111111 the ENiV ur till' hcsi .1~1 under UI"CI'I,,,"ly, "Sind 26," 1\ ~S I The diffeience '

$2.20

" ihe increase ill cxpccicrl J1r\1~l from ;1 Iree, PCI rC~1 p .. cdicuve d~'vicc" l lencc, $2,20 " I hee: peeled val .. t' ()f ,Jcrrcel inforuHU ion (EVP I), Thai",

I: VPI = EXjl~~I"11 1'l'n~1 wilh pcricci pr~dlcllon - EM V (of nplimal act)

I~M V (LI ndcr un(oI:nJ~III' ~ I H1I,

I\fl
-- ----
"Ol( .,., \w("llli \'Imt 1l ,rmt'll
~~IIIKI ~,\ I [HI ~,l'J IIII ~"~.IIII
ULI nil ·1211 II !O
~\.I ~" 55.1 In SSI _n $:1120 I· t:pC'I!:O profit l \~ Itll I~I:'. rcCI pre die lion)

N01e from lahl(' (, 'l that S2, 2() I~ ai,,, I he erperiN/ "1'I.mlllllP/\' /0,<.1 II[ 'he "plimuill HCI Wr uuglu ex peel Ihl~ result. smcc the perfect prt'rli':loi shnuld reduce the "pp0riunily 1(J~s IIHII exists under unccuulnry In zero, II~III:(', I"~ cxpccterl np portunuy toss III IlL,' npuuuun aCI measure, rhc L: VPI '\ ",dul ch~ck (In coml'ul~ IIl'PI~ I~ provrdetl hy the 1(llln"'Hlg Id~IIIIIY

I':MV (nf any :ICI)

, Fm (nf rhc same ,lei)

IlXPCClcd (1",1'11 Will, I"~I reci prcdicucn

rhLs calculnuun " <hnwn In Table {, 11

II ;~ irnportum In uruc tha: il is I he i',(li. olrhc (lJ'lim,,1 11('1 (hili " equal 1(1 \lIe F VI'I I I' the groc~r chooses I he ac I .. S I"" k 211," I here will he all F M V of $42 and an EOl or 'S 1 I 20. The EV PI i~ no! S I I 20, because I he ,t:rncer can me rcase til C I,M V to $5 I hy ~IIOU~lllg tI di fferen [ lie I (" Srock 26"), and I h i, rcq III res "0 addu lon;11 IMIl, rnuuon. The vnlur 01 addiuonul inlill ruruion is measured ,1111 ling from Ihe 11~ vumprinn thai III<' Iljlllilial action would he chosen, given the Ini',>rmill;on ulreurly nv •• ilablc,

lnterpretatun; « Eli!"

lhe EVPI cnn I". 11I("I):hl of as a gcncrnl mcuxurc of IIII' C(<lI1UIIII,' Imp"ct "r Ihe unccnuinty in the rle""Inil problem, A, rho nnrnc Implies, II '1 Ille value of ouunu IIIIl a per fecI prcdicunu A, such, il i, [Ill 11ppel hound on WII,,11 II would he won II 10 !lCt addiuonal In for maunn before nell ng If the EV PI I~ small, adduional mfOl mauon would not 1\('11' inuch. If ;1 ;~ R large arncunr . then rfu- ,ke"I{1Il maker should CXUI11l11C methods [or nbtuini ng ; n rorm~ lion before act i ng, M (lr,' "" IIII~ I mer in I he chapter:

l3ul since If I~ .iI'II the expected nppurtunuy Joss, thl' I VI'I IS " measure .1 opportunities fnrI\rIl1C, In this sense, lillie LVPI IS large, II IIUIIII<I be a si g nal rn rhe decision maker 10 M'l'k allcrnmivcs tl1II1 are 11111 currently IlI'illl\ considered. nlU i:VI'III1 our gfnccl'~ jllnhleln was 11m very I;!rgc ($2,20 per duy), htll if it had been II woutd be ar I 111011,.11 .un In see if the vtoc kilig problem cnukln'i he 'f'lvcd In ,I ,II f fl'rcill wn)" The ftrllCt'I, I'or example. ITIII~III urmngc In 11i10" IIII' Ilimy make IWO 1\1 uune ddivel'lc, (lCI 11:1)", with the QI11<llllll uu the subsequent d,'llvel irs depellilcl1\, Or! ,~Ic!~a "jusI· in rune" nivcntory system These m igh I have nrldlillmal COS IS , whi ell would need !O be evaluated. The pouu I~ Ihm EVPI can be a trigger to look for alternatives Now rlnu 111i~ is what happened in the Oglethorpe l'nwcr Tran,lm"sI"'1 I nnl ivai i 11g example III [lie bcgi nn i ng <lr rh i s chapter=-uie Ii I gli E V I' I abo u I I he COlli penn ve suuat inn prompted considerauon of alternative ",ay~ of 'I 'Uti uri Ilg (he de .el witll Florida Powcr

250

Sensltlvlty Analysix or SlIhjc 'live Probabilities

bl"L1Il1ll1~ ,"011,111,111 II:~ IS "lie 01 III<' IIIO~I dd Ii c 1111 <reps 111 ,lpl"ylllg Ihl' C\pc~lt:d munct.uy vnlu .. dccivron (111<''1011 SUI1I"11I1U" il " posslhle In avoid 110" ~ICI" ,II 1(':',1 p:nliuliy, by Ic"vll'!\ I he csumuuon "f PI(,hilhdll it'S 10 the 1.1" ['[11 each ncr, ;1 I""~~C 01 pruuahrhues cau he loumJ m'CI wiliell II,,· glvCII iI~1 I' opumal lhe rlCCI'JlIl[ maker 111"]1 lktCI nuncs In wluch Inlt)l viii rlre pi nilah II II IC.' he

We will IlIu"JalellH~ uWlg a PIt'VIOU, example In Table h 10, IIll' condiuonal V;lILIC, 11'1 ,J Il~\V 1'1 odm',1 del'I~lon were ~,Ive~ ($1 nullum Ii me rr\,UlICI IS xucccvsful; - S5()U,()()() II 01 1,111, .. 1 nd zero I ( II " nOI I III wdllced ) I.~I I' he me prohahrlr: y of 'Line". and h~n,'C (I I') I~ I he p' "''''hilily (11 fUllllle fOI Ihr new I" "ellIel, As,wIII mg rhe !lell"'''' m.rkcr "I,h", In usc Ih,' l- 1V cruerum Ih( c~pcC!l'd value nl 111 I,Ot!IIl'II'!llht' p""h,( I II'

l',M V 1'\ l,O()O,OOCl) ., (I /1)( 50()310(»)

~(K).O(l(1 I 1500,0001'

1'0" II,e p r ndlKIIO he III11.'ndlJ~~(I,I.MV muvt he grcaWI ihan 1,,'111 rh,lI II

~OO,O()O I I.SflO,IlIlO,J -. ()

or

.'i()O.OOO

p > 1,500.000 I

Hence, II Ihe elecl~I()11 muker [Iwls th~t the chnnces nrc grenici than one-third

for success, the product ,holll<l be 1111 I 01.1 uced ()!e rhat the decision maker does nOi

have II) SIJcclfy till CX~CI value r", /, IJI order 1(. 1IIIIke the dccrsron.

E~1111111h'

To IUIIIII,:I' dalll)' IIIIS COIIC':Pl. consider agnin the example or the grocer d"ddillg how mnuy C"M.'~ 01 milk 10 Ilock, I'mlll Tobie 6 I, we deiernuncd Ihlll the OptilIHIII' aCI ,"",1, II> IIIl",1. 26 cascv I Ius rcsul] w:" obuuucd U,IIl!! Ihe probabilnics m tlu; fir" cnII1l1", 111 Tautc (, . I 4, Y,1I1 can cited I!WI lite ncuon "Slm~k 211" r~rI1;II1" oprnuul for ,111 the vaflllll' ~CIS 01' probabiluics shown 111 Table I> I ~ I HCIlCl", the dCCI\io" mak\'1 can ,cc rluu the dcc.sron rs lUll srnsiuve t(I the V;JII;lIWnS Ln Ihl' probnhihnes thlll <II,' prcserucd I n Table h 14. Other va riali!ln~ could cauve a change III deci sion,

TAIII.I 6-14 i\III'I'III11ivc Po,sihlc ers or Prohahilitie.

S(.'tJ III f'f'(dJ(jbr't/u+\
£1,.,.;11 nrmnml .,
2~ •• 11;' 01 II' OOS III
u. t:Mlc~ 11,1 I) , IIlj 1),1
n l,.!II"'C!. 0\ 01 040 CII
21i1 r'IIM!~ !ll 01 0.'10 III ~TI~.· 11el ··S~IIi_:~ 2(J" rcrnmu-, ~1p.irLla' n ... IOII}~ ~l<:; IJ(dcIllJl11d := 2'1}· n 20 and JJ'dt:nHH~(1 ~ 1J1 c n.H:O I lip, model r IIr'",cJopt:,11D rll'f;1I1 In .1 IMh..'1 IChaplcl

251

1-1" example, If the prohalulity auachcd wlhe evcm "demand "r 1<; rll'c," 1, gIC;IIC, 11i'"1 0,20, then the O"li[11111 ciCC"'UI1 ch:llIgc, III ",dellll!; 2~ (''(,c"

I hc gcner;,1 appruach wggc'lcd hy 1111'. C' .1I1lplc i, {1!'I<"i .... 1I' (11111/1'.<11 rhe dc ~I'1(111 makci IIlakes:l prcluniuai y ~l'll'1l csum.ucs a", p1'Ol1"hlllll\" II' 1,11 p:IYlllr.,j Val'l.II'f'n\ In these C'III11:IIC~ arc Ihell made If the \'ilri,lIu>Il' dn mu changt' the up umnl tll'CISI!'l1, line need go 110 [u: 1I1~1', Ir,I11llill' other Ilill1<l, lilt, d~ClS"'I1I~ scusruvc 10 I he change', then Ihe manager IIIU\I rcnnc I I!~ pi chnunarj CSII, 11.11," 111 onJel to "IT!\'\' UI n rlccisinn.

Summar

The CKPC<.:lc(.i value of pCI l'cct urtru uuuion I~ lite worth 10 the dCCI'IiIl' maker Ilr n p r lcct rOlfe,ISI of an uncer tam eVClI1 Scn'lIivll) 30,,1)'''' cxarrnnev the degree to wluch [l d"'I';"1I rlcpcnd~ "11 (i, \('I'I,itlv(; tn) 1"'U111PlioI11 or ('.~I;trH'ICI, pari iculnrly c"111t.1IC' 01 flfl1oah,Illlc,

Decision rees

I'he previoLis sections or rhis chapter devclopeu the dcc.vion c rucnon or c ~ pee ted runuctury value and analyzed si rnple deCISIOns Llsing cO,I\llIlOnill \'"IL,e tahlev lhis secunn dcscnhes a general approach (m more complex dt:~isIOIl' Ih.11 's II scfu I hnth for 1'/1'1(('[1"1,,,: the dccixion prohlcm and fOI iindlng a \Olll[,(1I1, l'he approach L1t1Ilie ,I clec;<;;o" tree, a grapruc 11101 [or descutnng Ihe aCIIO'" available 10 lite dcc i<;1011 maker, lite events Ilwl can occur.jnul the rclfninn\hi" between Ihe\e: a<'110I1~ aru] events

/)I'l'isirm Trco [or Grocer ',I' I'robtetn

Ii, ,IIIISirmc II,e hasrc ulc.iv, let II' iir,1 develop the decrsron tree fill ihe I1rf1CCt), problem of the lust seci lou Recall ihm rhc d~l';'ll1n mvolves hnw many ca~c\ Dr mi!1 k 10 order. Tile II~C[Slon rOln[ ,s represented hy OJ {qrWr<' /)0,," or dUI.H()J1 node In hgurc 6-1 Tile aiterl1alivcs arc represented us branchr« crnanaung l'rorn the deer~Ion node

Suppose Ihc grocer were tn sclec: some paruculm .,llcrnrtliw say, order 28 cases There arc several ,,().,~ible events Ih~1 can happen, each event rcpresentmg a number of C;I'C~ of milk llml customers mlj!i11 demand These ,HC shown III FigIIr~ 6 2 as branches em.loaling from (I round node, (We Ille using IIIe convcnuon of n square box lor a dcciston node ilnd a cuetc fur an I'WIll node ) Note. 111111 these I>,UIII'I,CS I'!!PI'CSC[H uncertain CVCI1IS over which the d':CI"Ilr1 maktl[ has no corurol. l lowcver, pWh.lhlllucs C,lII he 'I~"gncd III ench event ilnd ,rc "III.'I('d umln each brunch in pUH.'!llbcscs

AI the curl of each brunch I,~ the condruonal profii ,,~~ocialed 1.\ IIh the ~CICCICd ~CIII1I1 and given even: (111C same values 01.1 III ruble 6-2) The cnndiuonal 1'1'0111 thus represents rhe profil n""ClJlcd with the deCI~IIlIlS and events "'ong the parh rlOm the nrsl pur; of IIIC tree Il' I"~ end I'm example, tbc $26 ![I IOigLlI~ (,·2 isuu: profu «1,OCI.1led wuh ordering 28 cases of rrulk, ~l1d then cxpericncrng il dcmund of 25 crl,es

251

Fi!,IIIH 11-1 ( ;rO('tll'~,1,j Alll'nlilli"l"

Fi(;uu~. (,-2 Events for AII~I'n:lIlv(' "Orrll'" 211 ('11"""

o rr! 0' :2!J case S

Orde r 27 ca58S

Or~or 28 cases

/:

/

rr~

i\",", '" '""""(

AII8rna~I'I,i(]S

, , , , ,

l vun' .,uc..J.IJ

CCllrrlllCl(1Lll nmtn

Damand 'S 25 cases

10101

Dornon.cJ is 26 canna

/.- - ----.

V (0301

30

'~mand 18 27 c:'_s<>. (050

Demand 15 28 cases

5G

(0.101

The expected HILHIC("I y value (I:.MV) is calculated for CelL'11 even! node exactly as was done in the rr~vi(),,\ ~C~lI()'I (see Table 6-6) Thill", 1" "hl,hllllic~ are multiplied by cnndi I i clilill [11'0111, ami ~ U In rued: The E!VI Vis pi aced III the event node to indicate that il is 111C L'Xp"t'!cu value calculated over 1111 b"lIlC'ilt', ~manal ing [rorn Ibal node.

CDM,I,O""' prol"

S50

Oorn,unl IF. 2S c j !,t! ~ "2
OHIO' ?It C:'l~jC:; G><:IO 10)
, .
,1 ..... Domund I~ ~ti, '2 ~ Or i'3 CDOCS 52
'I! IO,~JOI
.~
1! DI1[lUlIUJ Ii, ,!, ca~,cm
" 34
(0101
.'" ••
~ Or~or U cases
DemaM I~ 21 Or ?B """0' 54
{Q 601
~
"' DlJrn.arltj [R,,2ti C:'[)PiIt~
26
AIOI
7 -(~~~J;;;"" '" "'" 36
Ordor (.If], cnm[~
I 2
,I DemlLn<ll~ ?{ CII',IHL 40
.'11 0501
., Dam.[]I'," I~l 2U cnunn 56
'.' ~
1 (0101 t'II'IIft' (, 1 shows ihe cumplcre d"~I~IIL11 tH'r (or rhc grocer's problem NfI1c- rh •• , 111' 11111 IIcr""n ry In h <;1 cvery pn,,, hie even: '''P,1f .nel)' [or all dccrsions Th II ~ whc'n 2(, C,ISI', IIIC'. mllcrcu, I here ILl C (\1 II Y I WD cvem ~ II",! lead 10 d I rf" re III C<lII<I II iOIl,,1 I'l'oli!~: 11('IILiIl,,1 I~ 2.~ cases with I" prohl 01 ;j,112: 111111 d~llIlInd i" 26 nr more (Ih", ", dcmuud il 21" 27, or 2H c:t'c",) with II I'l'Olil nl' $.';2, If the grncer Of(l<"I'~ 2~ CII"'-'. there If, flllly "lie outccmc-c-namuly, IIIU ,lilt, Oil' .ill 2.~ cases with ccmlit ""wl [11111;( 01 \50

In lrgure 0-3. the C~p"'CICtl moneta, y VJluCI arc shown in the event "odes '[:be !lron,r 11111,1 Ihen choose which ac lion (0 IIIKe, IUIII' I lus choice is 10 selec I I he I"'" wi I h I he h ighe~( 10M V -n;r mel y, order 2(, cases w 1111 t;:M v = $51 , T hi, i s L nc! ic :",,,,1 III III~ II ce by pun i ng .~ I ill the d~CI~I()1l 1H1(lc (,ICj 1I ~ I'C box) at (he hcgi III' i ng (,1' lite I rce. In :IUtl" inn, the mark II is drawn across IIw nunuptimal decision branches. m llic"'lllg Ih:1I they arc not 10 be followed.

III 1IIIIIIl1ary, I he deci.\llill tree usc \iLe same idcn or lIIilxllni/illg expected Ill'", ctar y varue developed In I he PI'C"I(>us -ccuon. for the grocery example. (he use 01 " table. sue]. ,1S Table 6-2, ",ay "'till ".l"er, IIOWCVCI, ill 1101' (ktl;ioll problem be COIIl~' I nOli' corn plex: [he dec I '10111 [ret: hccnrnes 111{11 c vnlu nble In orga II i IIII~ the ,"fI1l111," i"" "ceded 10 rnnkc Ill<' d"t·l.<iml, This is especially 11'11' if the manager 11III;l make ,I .II'q!ll'I!Ce of dcci sions. I llllll'r I han a single deci \11111, ,I, rhe next example Will rllustratc

Declslou True I~xnm pic

Suppose the marketing rnnnagcr ol a firm is lrying 10 decide whether or 11(11 1\1 market a new product and 011 wh.,1 pnc e 10 sell u. The pmlll I" he made depends nn whether or not a cornpeutor Will uuroduce a srrmlnr prnduCl and on what pnce lh" com rei I Illi charges.

Notl' ihn: there arc iwo deCI"IIII': (I) i ruroduce the produc: or not , and (2) IIIc I''''CC I" Chill gl:. I.; kcwi se, I herl' <Ire I"", even I, (I) C(1I1l,I'Clllll1Il 101 rOciIJCC' :I I'(JIII peuu ve produci (01' nor). ;1 nd (2) the compcrnor's 111'11:1' l'he ummg or sequence III I hcsc dec Ismrl~ II nd even I, I' WI) 1111 porturu 111 tlll\ dec I \11111 If the 1l1~ rket: ng 111,111 ;IgCI IIIIISI IICI before knowing wll,'llim (1[' lUll the Cnl1lpGIIHH' Im~ H sirnila, ]11 OIlm:l, the pl'ICC II Illy be d i lf ereru I hn II W" h such k now I edge A rl"d, i nn I rcc i, pa rI iculur I Y usctul sn rlus type of'lllmllull vrucc II display, the ordel III which deel~i"n~ ,1[(' made ,I mf events occur.

S LlPp\l\~ III OU r exam ric lI1al thcl lrrn rn uSI In t reduce 01 decide !O sera p i lS new prod uc I short] y, However. I he ]11 i C,' dec i, i on ca 11 he IT! fide I nrcr 1 f I he compel i Inr i~ goi ngl 0 ncr. II will inr reduce II" pi oduc 1 wi I b ill ~ month I nih rec months. Oil I [01 III Will esiabhsh and announce ," pncc Alter rhat , the comncntor Will annnunce Il~ price, Thl~ C,1I1 he diagrammed III lI,r decis.on tree In 1:1&lIll' (1 ~1. Nme thill Ih,\ " u ,cq"~1111111 tI~~lsi'''1 prohlcm, ChI' lir m 1I111.'t make a deci\"", 111M "hOUI introduct "III IJI>(i .1I<1i"",/",'IIII)' ,~I price. ojll" 1~11""JlIl ~hClI.II rhc Ctlm]1(,I"",.\ 111;11(111

I lie dCCI'lOn I ree shows 'Ihe structure or che dC''''')I:1 1'1 nblem To complete I he analvsrs: couthuuunl rrOIII' IIIIISI he \"1 rrnarcd ror every cnmhinunon of aCIIOI1\ ,lnd ev,\I'II~ (uuu L~. for every pHlII 11"'0"1',11 II'e I rcc). Supl''"'c nur ruurkcting m""al.'.~1 11.1" rio! Ie II, i, .. LJld I h e profits n re ,I HlW" III Figu rc ()-.~ a I Ilw C.I1.d, or the tree, The,c', rfohl values Include the co," ~ 01 1111 rndccing the product ""d I he profil.' made fUl!I1 I~' vale N~gal"'c values rndicutc lhal mtrnducuon CO,I" exceeded suhsequeru profil frorn ,aiel,

A I S(I, II re prnhabil il i cs fm clld I ~V~111 rnux I be a~sc,,~d by t he dec i,i O~ maker: rOL ou I' exam pie. I hey are ,III1WII [J nder I he even I bra riches III Fi gu re 6-4, NOle 111m I hcse prohJhll1l ics may depend (Ill pllnr ac I ions or events 'J hus rhe probabilu ic~ fru ihc COll11l~lllur", price hchavior HI h~ur~ 6-4 arc tilrtl'ICIlI when our price 1.1 high I hell when 0111' price i$ lew,

tnjluenc« Diagram

We cun also represent liLe lIWIr;'I!,cr\ problem usmg 1111 fllj/III'm'I' diagram, See hr:lire (, 'i Tid.; influence dillgrilill " quire simple, ,0 u inny 11111 seem purtiruhu ly hclplul in -tructuring the dccrxion problem and the decrsiuu lice. However, for more complex SIlUll!IOIlS. II may be vet v useful 10 draw an mtlucncc diagram print 10 dcvdopill!; [he detailed decision ircc: the i nflu ence di O!(ml1l would be an cxcetleru way 10 structure our ao><Hllpl i(lll~ about the irnporuuu I"nc\(-,,.~ and relationships ill the mnde I, 1 n genera I. we r~COIlHII~lld us i ng decis ion I rccs : 0 solve problems "I' Ihl~ I) pe

I'I(;(III!:: 6-4 Dcci,inn I r~t' for Produci 11'11 rml"<'Oull Exam pie

1fl.lmdul.:1'P prOC:hic::t

('IoIenl$

CUI"IJ~t"IVG producot In I(O(jUCM

(

AllfJrnatl'lles. (lliJf prlceJ

S et low P flcn

, S~, hlgh P"co

No COfllPOIIII"" . ~

produCI IT _ s~, 1'''"''

(O~I : ~"co

~ m::ond dec~SlOn POI"1

~vonlS (r:OI'1ll0'llor';S P"I U)

Com rl', In I,n' pr~IH (WO(l)

c

H_g_h __ SI',Il
103J
Medium
0
105)
low
zoo
(02)
H!g_h ___ ~~,o
10 I)
MedMn
(06) 100
Low
10,3) 50
H'~ 100
(01)
Medium
-._-- GO
(O2)
Low
-loa
(a 71
!lOO
~(JO
HI()
() FlGUref. 6-5 ]n!lll~ncc DIII):l'lln1 for I'r'ntlucl lulmduc(inll EXlimple

comn~I:)-llvO

produci )0-

lnlrociucod

JotJDdfr-ce

produci

lor not)

256

II nalysis IJf the Decision Proble».

To analyze .1 decision tree. we begin al the cnd 01" ihc tree and work backwards. 1:(11' each SCI or CV~III brunches. ihe I~MV IS culculnied as illusunted. and for each set of decision branches. the one wah the blghcsi EMV is selected. This I, tlluxu'ated in Figure 6-6 for OUI' example. Fir~l. the EMVs arc calculared for the event nodes associated with ccmpcutors price. For example. the [MV of $5,000 in the topmost right circle in Figure 6-6 represents the sum of the product of probabil iues for high, medium and lnw pnces I i rues the respect! ve conditional protus:

EMV = (O,Jl{ 150) + (05)(0) + (0,2)( - 2(0) = 5

The other values are computed silT.ilarly.

FIGwn: 6-(. Completed Decision Tree rill' Product lnt roduction Example

Evenls

loom POIII or. prlcej

Allemalives (our price)

Set l"gll price

High
10.3)
Mediium
5
105)
Low
102) Alternatives

Cor., pa II t Iva procuc: lntroouced

Low (03)

Hi~_ (0 I)

Set medium price MeeJlllm

f--------'------{ 70 ----(06)

(08)

High

lntrcouce

proouct ~ 156

(0.1)

LOw

(071

I SOl high proce

NO compelltlve~

~O~CI __ 500 H __ ~Gt medium P~ _

(0 2) I Sallow pnca

I

00 nol Introduce product

First oecisicn Second d ecis Ion

pain! point

C Omll t iena I proth (SOOO)

5150

o

-200

250

100

-50

100

50

-ioo

500

300

100

a

257

Now. il' we move back (HI the decision Ire,' 10 the ~CC"II<1 dccrsion point. we arc luccd With two decision suuauons. Tile lirst-,wh~n " rumpcuuvc pLOrlLICI h,,' been I n: ruduccd=-: nvol ves $~II i 11g. :I hi gil, I11cd iu m , ,,,. low PI'ICC wit hex peeled p rof I'; of $5.00(), $70,000. and - $50.0011. rcspccuvcly A,SLIlf1e IIIG enoree " I he one wu h 11Iglrc'l expected prC'lfil-lhc medium price, A mar k II I~ placed un i he uncs 1"~1'IICd 10 the other ahcrnatives. indicating that they are nonoprimal. 3ml the expected profit of $70.000 i, attached to the upper box <If the second decision point.

When 110 competitive product is introduced the best choice is u lugh price. with profu 01' S500.DOO.

1\1 the event poi ru ro the left. <In expected value of " 156.UOO is computed hy multiplying the expected profu given a cornpetu ivc product (S70.0()O] by 1l~ probahiliiy, O.R. and adding the profit given no competitive produc: 1$.'i()O.rlOO) lime, us prnhahility of 0.2. The RMV in thousands IS:

t':MV = 10.3)(711) j (O,2)15()O) = 156

Finally, ihe decision to market rhe product IS Imide, since the expected net profit 01" $15(1,000 i~ greater than I he zero profit from nOI marketing the prorlucr:

Note that the decision 111m result, Irnm an analYSIS "I' the decisio» tree is not fJ fixed decision, bUI rather it is " strategv. Introduce the product and charge" high price if there is no competitive entry: hut charge a medium price If there is com PCI i t in n.

Developing IIII! Decision Tree

The decision rrec is iI model of a decision siunuion. "nd like "II modcl s , it is all nhstructicn and srrnplification 0[' ihc real problem Only 111C 111I(Jor1;Ll1t decrsions and events arc i ncludcd: othcrw i sc, t he I ree becomes tOO "hu S II y," And j udgmc III is rcquircd , not only about what [(1 include. but also 10 assess probabilities.

111 d ra wi fig II decision I rcc, ceria ill rule, 111 ust be obse rvcd:

I. The branches e.nunaung from any node must he all the same logical type, either events or attcrnauvcs. and never a mix (1f the two,

2. The events associated with branches from any event node must be mutually excl U.I i vc and all CVCn!S i, IlC I uded, so that the sum (If I he probabi lilies is one.

3. The alternatives associated with a decision node must include all the atrernativcs under considerution at rhm poirn.

It is generally helpful to develop the tree In chronological sequence. so thaI the proper order or decisions and evcrus is rnainmincd. However, some O,pCCl~ of drawing the rrcc lire arbitrary, ["I'll' example. in tile e(L~C above, suppose ihc firm must announce it" decision abou: tile 11CW product find establish the price before any infor Illation abou l tile com peiliur IS k nown The pa rt of the tree rcluu ng 10 I hese decrsions could be drawn in either 01' the two equivalent ways shown in Figllrc 6-7, Exactly the same options would be available for diagramming the events associated with the cornpcrirors product iruroducuon and rhe cornpcrirors prrcc. if they occurred without any intervening decision on our furn's pal'!

Recall from the discussion of risk earlier in rhc chapter iha: expected monetary value is nOI an apprnprinre decision criterion if the conditional profits or losses are

FI',I)1(1'.6-7

III'rI1111il'c Way~ col Di:'I!I'zJIn mi ng I kci \ lOll (revised ",~H",ple)

SIIIIl IlICl ry

Molhnej 1 Sol h'qr ptoce

Mnlho<l2

lntrnduce

,~-{ r Sui IIlyu,um pnce

/

\ Do not "''','',,'''''',,',,'

'\.SOI 1001 pr ice

Inlro<l" ;p atld lot " gil puce

") 1,'I'ge Ihnl the dec-sum milker Views rhc alrcr nuuvcs as havlll~ ~ll!nllu;:anlly dirCcl' em xmscquenccc In such vrrunticns. 1IIIIIly v,tlm', are used III tlw denslOn Ire" In 1'1,1( I' or cond 11 io 11 ill prolllS, I lus rs considc: ~d III de I a il ina later dill !' I ~I,

,\ Ilc~",,," tree I~ ~ !'wpll1<' device {or shnwln!', [he sequencc 01 dccisron ahcrnuuvcs .II,lI ev 'illS mvolvcd III 111111,1111-\ II decision under unccnamry A dC"ISllliI tree is (Inri 11''''11 h)' calculating 111C ('XIWCICU vnlue fur encli event node IIlld Chll"'lllg ihe altur IHIII"" WIIIt IIt~ hlghcsl prohl for dccisron 1l<1Iks, s!nrlll1& .... 111 the end of the tree and rnovrng backwuul IOW,11 rl the origin.

St.ncl( Options lind Decis ion A ualysis

111 Ind,II'\ financial ma: kCI~. there arc ~ nuruhc. or financial instruments Or dcrrvaIIVC' that take Ihe fmlll of an option. Their evaluauon IS a VCI> 11111""'10101 and prnc II, ,~I upphcation 01 the dCCISllIl1 AnaIY"1 III",/IS W~ have discussed, III we exarnme .. llIl'l- "p[i",,~ briefly

I" \I, whal IS ;1 Hill t: optran 1 There are m .. o.,.. varrauons hili II. 'he simples: 11>1'11, a (011 opnon I~ Ih nglll 10 buy" ",(llk ,II srunc future d,IIC •• 1 n given price In 1111 Amcncnn puon. tilt' upnon can be cx(:rcl~I'(IIIILY ume lip to the expunrion dare:

III ,I 1:111'{lPClll1 01)11011, II .~ exercised [\11 the expiration claw I 'ow should <III nprion he '11111~d~

A, u concrete cxnmplc, 'II ppose YOli Me ).\1 vcn (by a nell u ride) an Opt ion for 1,(11\0 ~harc<: of VClllIIIC~, IIlC, 11 is a Europcnn vn r iety option find will expire in ')0

<lilY' rhe call pnrc IS '!.22 PCI ,hall' IIII' rill ,,'nl pncc 01" ,II •• ,,' III VCIllIIIC~ In< I' Sl.() Willi' i, Ilw "pIIOlI\ value? CI~jll'ly, till' value depends nt1 what tile pi 1(''' \'/111 he III 1)0 days If IIii' P""" I~ at (II" helm., '1-22, I he option h", IIU v .. luc, <II1C~ I'll" wOllld 1101 buy d stock ,II ,III opuon pll' C 11l.11 " Illghcr Ihl111 whm VUII would p,.\ (111 IIIC open III a r kei 0 II tile nt her hand, " I he 'lock PI'ICC 9i1 II II Y' II [\11. now I S, ,I~, ~2('i, you could exercise II,e opi ion, h,IV Illc 1,000 shares f"r $22 pCI' share. 1111.1 IlI1l11e{hately sell them on Ihe mal ke: f". ~7r., making 11 1'" nilt of M per share or '\,.1,000 In rourl

1M order 10 cvnlumc the OpIIOI1, we 1111111 huvc some [m,lIulllIIlY distribuuou r," llie sroc k price fOI V~ 11I1II'C" Inc. II. !)O [I i1 Y' A It hough I he rc II re soph i SI icated I,noil ds III finance for ilnalYling stock pile" movements, Icr us "l11ply ussume Ih;u the pmbabrhues given III Tahlc 6-1.~ have h~ln csumared Nrue IhOiI the expected puce I" $21,74, below the ('1111 suikmg price 01 ~2l,0I1,

l'hc value or the 01'11011 I, c,d""lllIl'd 111 Table 6-16 lillie 1I""k~1 price .1) 90 II'IYS IS below Ih,' '!llkin!: pnce or $P the opuun I~ nOI cxercrvetl and there ., lei" vnlue. When the P!'lCC IS ub VI! \22, il I'",fil IS realized by c~,,,cr""~ rhe opuon ;;11.1 reselling rhc sroc], ill II,e market price, l'he cxpcciee return " calculured at $1 1<1 pCI share, Ttns IS the value or the Opll(111 Note rluu rbe oplinl1 h." value even 1111I1I)!1l I he e xpecsed price 01 '521 7d (sec Table (, I ~ \ IS below the SIU k mg puce of $22

NOLe [hat the I'rocc~~ I, the same .1\ w[~, done In calculrue I he value of rell~, I IlifOl1l18li,1O in a decision silua[ion The vnlue of an opuun nllows one 10 act Willi perfect infnrrnation rhat rs , after the ncrual markc: price rs know" There are m,'n~ mher optionlike mvestmcm vehicles In Ii 1lI1nI·C, and elaborate models have been de vclnpcd 10 cv~I\ill\c 11'1"", ;~II relyLng 011 the uurlcrlyutg concept nf dccisron Rn,,1 )""

The option ideu C[II' 111'rI be appllCl1 1[. cnpuul invcs: il1CIII~ III 1111~1I1es~ (sec 1111' hn~ nn how Merck uses op"ons Ihenl Vi i!1l\lIleS'e' make IIWI"tIlICI1I\ 111 re~elll(.h III cqmprncm, anrl III rnnrkeung, hUI Ihe rei urns lire often hl!:hly uncertarn 111 Ilil eX1e11l Ihnl a (ir m CAll nhuudon a [110.11',,1 ill YIII.tllIS stages !1I1tl Icchu:e II;; losscs , Ihe IIIWslllLl:llt can hl' viewed ,IS An opiiuu 1'01 example. n firm frilLY he able 10 (in ;1 prelumnary rnnr kci 'Iudy !lr a new plllduct helorc bUlldll1g the production r,'('11 II.el, only hu.khl1l1 rll(' f"c,lnre~ Ii lhl' I!HII kCI ICSI proves poviuve enough Sp~ClIr,·

.~wdl I'fr("e jn/" V'erlltlj f< Jrtf IPI t}()dtH',{{$,Il!.1 111(111"'1

s 16 I R 20 22

f) 0) (),I,I I) l~ 1I1n 11111 (\10 (10] f)O'

11K)

\'lf1t" I'f 1('(' ((II Of'l '\fI."
Vt"IUiUt'\ "Ir III 911 I u 1(1\(' D,u ,n'l \i1hir I .,"Clrri Val""
I'm" ,111<" rhn!" O/'!UHI (Sf'''; .1,,,,,,.) "'{1-OOhll"", CIJIt:jllllllOJI
1(, No 11 DDS $0
IH 1'1" il O.IS 0
20 No I) 025 I)
U l,ndlrrC'oflll 0 0,20 I)
24 Ye, l 0,20 OAO
26 Yo, 010 OAO
!8 ,'t'r., 001 0.18
'0 y~, 0,01 0.16
hU1l1 ~I I ~ c~.lrnJllc,~ like 11m 111\' cnnvutercd III the next 'C"If1n, We wl,1i Illt'll'ly (Cl note the pur.rllcl tu nplillil I iL",111' V, •

Revision of Probabillties

In 111 i s sect inn. we i 111 WtJlICC (he Opp01'1 LIlII1 Y 1\1 cxperi men I: (hal is, I o galher addiurinal mforrnanon ano revise probabilinev before making the decision

We shall deal wuh the "mrleSi of pussrblc suuations where IllCIC 15 only one unknown, For example. the decision mlLY I,ill!~" on the demand IO!' the product in the nC~1 year, AS,IIIIIC II hilS been dccrded In experiment Dell1ilml is the only un known, In Ih'$ <l1l11l1lon ("hKIi could he .rn mvcniory problem), the "co~lon process IS ,,~ lnllow»:

I hoosc tile decision cruerion: we nxsurnc the expected value decision rule,

2, Describe the 'cl IIr (In. sible O"ICOI1lC~ and possible dCCI\l!lll\

'l, Assign probalnhucs III the po"ihle nutcorncs (slates 01 n.uurc]. 'I. Determine II pl"llfi I lunc lion (cond illllllal prnf IS),

S Conduct an cxpcnmem

(\, Revise the ass l!tncL! prnbabili lies

7, Cornpu Ie Ilw U~ pee lcti pro III for C [Icll ([cels i on.

R The Opll mum !II' ('IS ""1 " the act IV II h I he highest ex peeled pi nlit

The above proces» IIS\Ullle~ [hal II h:" 1""\ lOusly been dereruuned that experi mcntnuon is dcsimblc. We IlOW invcsugnn, 111111 question.

'I'll' Value of Imp 'rl"ect Information

l lcru, We shall uurnducc II general mel hod lor cvuluaring the pnssihitily or obtaining mnrc mforrnanon rcgolrdlll~ n decision prnhlcm

lSCC A IJ i ~Il 4HHJ 1< Pmtl~( k, ilrH!flrIJe'1lI WI"t'r l)Prl i'j IOrrH)' (IJrillcclo11, NJ PIIf'lc:.c:WIl Uill vcrsll)' P'U:I!.. IQ94l. wheT>!:' II'U>Iii [IMljll",·111." dt",t:~oped In deL,!11

. ...

eel. cvt'nt~ III ILl derer nune !IIC "iUt.l·(" .... Ill' 1.ullllf'.11 V,1r'Oll\ ,llIgo'\, tlnU nn"lly 'In ~WI1I uorlc WII II branches 1m I he va lue re.I,lIc,1 Il0l1>(",, I he product ,,' brouglu [n rnurket. (Sec problem f> II, I::vcrJ:!' or 11 Phnrrunceu lIe,,1 Cornpa ny, fOI " el111" etc ex: III ric) JlI!Jy I."w"nl ~lIti her staff I",V(> <lc,'dnpecl ,,,ph;II' eaten nu-thnds, bnsco on Mo,ek" nl"'rtC'Kc. for CI ~I unung It't nketrhood of ~"CCc" ,II ,',111(1,,, ,!ages an,' the CO~h 'H\d ulrrrnnte value of II Jlt~\, dr\.Jg In I he: IIlil. kCI Tht·y Ih~11 me II tccluuquc ,'''Ile,1 !vi",,, I' Cmtr. .j'\.n,jjl)I~I\ I(H t"\!aIUI1IHlg rhe tree I MOl1lt: f'arln analY\1 IS ('n\>('u·d In .1 I;ucf chapter Ihll the h.iI'1L .... uucrurc "~I the l'",hl"111 " the dccrsion lie,' ," ilcvclopcd II'l II", cilnlJI"1 I

l I

'apital I nvesuncnt Decisions as Options

In II rC~CI1l mu, It' 111 lilt Ihll'1Wl'ti nlnnUI,'(,\ 'l,',IVrl' 1". iluly l.ewent. I". chid llnuncrnl ollle"I' III MCf"k-a leadrng firm rn ihc phAI1l1ilCCUllc.11 mdu,"y was rnI ~I viewe d on flo'" ,IIC II ntl her "Mf eVA 1",1 I C I he hr m s ""'1m investmems III drug research 11 lokc~ nmny )'~<lr, 10 bring a (Irug III marker, and nl~nl: 111C way are suhstanti al invescmcru-, rn rexenrcu. Cilllltnll!lall. and producuon Icchnollll: Y nmounting In 10181 III several hundred 1I111hon ([,1111111, und the rcturnx '"" Ilighly II IICC 1'1" 111, H lSI, '"ellil y, -, OUI of 10 prmlllcl', (In nOI iecover 1hls m\<~·".lmenl Judv lcwcm liHhL'il!rd. "Optil'" IUltll)'~I:". II C Iht· kllld u~cd 10 \I.tl\JC \t<lt.'~ up I"",!, provide ,I 11I"'l! f1C\lh1c rtpPl'ortch I" vnlurng utu rcsear h iU\ln,lnu"IH~ lhnn It:HhIHH1t~1 IInHIH:1it1 L1nalySls bcc.I",' LI ,Lilnw' U! '0 "".h'RlC 111("" ""'csl· menrs 31 succesvrve \lllgC\ of a PIOJCCI • ~

nIlS decrsion I'rm:cs, can he co""tiol.1I a, .1 deer'If'" tree wuh SCV('1'1I1 Ilcc""m I,oj 111\ ~I wluc I, II," 1;1' m t.:1111 cheese [0 cunuuue IU III ves: or nh.nulun , hr prOJ-

~"Sc":nClrll MilnagCtTH;nt.1C ""h:ul>. Au lnrcr vrc w wu h CFO Jmly 1,C:WCllt. H{lrv{lrd nLt.WWH H~,~jt,_, Januar .... Pcbruar y I t'i)l1

Tile expected value of pcrfe I IIIlollllltilOU (EVPI) IIHmtlLL~ 'd curhcr s~I' ,111 IIpP('r hnu: 1111 Ihl.' "tim' or addi! inn II 111101'1111111011 III a dcci,iflli \l11"'II"n Moq Itl for maunn lhal \Ii(' can "hlilln I~ imperfect III the sense Ihm II IVIII 11'" tell us cl, ... lly which event Will occur Even $0, 1I1111<"r[("[1 rnlorrnauon Will '1111 huvc value If II wll! unprovc lite cxpucu-r' 1'1'1t1il,

The icrrn t'i/wrm"'IlII., imender! i1,,,c III he very broad II" c~[lnlmen( rnuy hL' ,I 'Iudy by ecnnnmrsts In predict nauonal econonnc acu VIlY, ;, consumer suryc) hy il rnurkCI research firm, un opinion poll cnntluctcd on behalf of ;1 pnhucnl candutarc. II sampl c of produc lion hne items I nkcn by an cngine~r II'l check on qu alrt y, or n '1.'I,mIC rest If> ~I\'~ ;[1\ nil well-dnllmg llrm lome indicarinns of Ill(' presence 01 ml

III gencrat "'i' ({III I'Vlr/u(lle lIlt 11',,011 of a given r'I'I'III11('1I1 ,IItI,' If u.r < 1/1, ,"/111/(111' IIII' rl'/trl/li/",\' or 1111' resllillllg III(Ol'llllilion, A mar kCI rcseurch study 1II,ly be helpful In rlccitlillg whether or 1101 III iutroduce n new product. However, the cxpcnmeru can be given a speer rc econonuc v .. luc before IIIC sunly only if the (It: crvion maker can ~'Iy hdorchand how clo\c;ly Ihe marker research 'Iudy can e\1I1 I;:IC lite potential sales.

1-\11 example Will make thiS clc.u SlIPllil.,C the sales or fI pUIClllili1 new p rod .. , I .... '111 he cuhe, lilI8e rn vmall (I he product Will Ill' either il \IICCC" "r a flop) rhe comhuon a I V~ luc Iolhl(' for tbrs deci ... lOr) 1\ ... hown In Table {J '7 Tile condmunnl value (If $4 rnillinu i, the net profit (prl'Stlll value) if 111~ l1(ltellllul ,,,ks CLre 1,1IW The $1 rTlillron I~ Illc ~()'I if Ihe p'WIUCI ~~11~ pomly,

'['AIII,!',6-1.7 CU!lfIlHlI1ml V!d,,~ Tllhk fIJI' Dccisinn "11111 t rud ucuon of N,'''' l'l'oduct

($ rn III inns)

: I

1'14.(1111; 6-8 ,I !! 1'1 !!C!!CC Di").\,",,,n fnr Prohlem on

Int roductton of New Product

At'tlmlI

"'~11 ."'e< t.ow "'J.I~:s

, vpecrcd moneL.1I 'i ~ 1.lut

11:1 117

,til )0

III

II II

II

Bmcd nil C~l'l'l'lnl ll10nClary v:d'IL' (I,MV), rhe IlliliclIlCci acrion 1.1 11<11 1<> imro!II"'" rhc prouuct However. ,I>e decisinu maker, I,uil'll u-Iuctam 10 give "I' II 1"""IJahlhlV or 0 ~ ,,1 m.rk IIlr Sol mill i<'11 , '11.1)' c onsidcr galhCIIIl)' uiure infnr 111"1,, rn helnre IIlk mg nc lion ,"'" I"" ~ rep, lei "' ",kliiaic the cxpcc ted value of [,nrC!: I IJI for rnauon (nVI'II, 1I.~·cilll rro", "arli,cl in 11m ("hapler II,,,,,

EVPI

Wirh :J perfect prcu-ctor, the company would irurndure rhc product 11 Silks were hlAh. and not "'I1""IIIC,~, if sales Wei" low. resulting in III, expected vnluc of' 0 3 X 4 o 7 X 0 = I 2. I he EM V of the opumal an (do nOI uuroduce) is zero lienee,

EVI'I

1,2-0=1,2

Thus. there h an expected value of $1 2 m .llIou I hal can be ohia ,"cd through perfeci infnr mauuu. lhc value 01 "Tlpe, teet mforrnnnun will be less

The dec i~H III IIWkl' I' can per ['01' III 1111 ex pCI' 11m 111 ill 1111, suua: ion S II ppose 1I1e expcrunent lolh,,, the '0' "' of a mar~cl survey couducu-r: rn 1110'0 rcpre~tlllJlllVI' t,1 ics. I he "!rvcy Will en,1 $0,2, milhou

There [Ire li'lI'\' p(l~~i.hlc OtIlCOIlICS flnl" the ~IIrV~Y' (11 The .llll'vl'Y III:IY predict ""r~~% (high ,nl,'s) fur III~ new prrulurt ; (2) the ""I'VCY IIl:'Y predict filillllC (low \alc,); or (3) 1 he vur vcy fc~uh may tw mconclusi ve In I he p.I~1. sur vcy' such as the nne proposed "[H'II vnrrccrly prcthcterl III" ~UCCC,IS or fudutl' of a new Ili"ducl, bUI '0'1 ICI i me, success WflS pred i cleo for II PI"UdUCI II,al I fll ~I I ailed. and \' ice Vl'I'SIl,

I r tne mar kC!lng manager lake' uic survey bclnre ilctjng, the decrsmu cnn be hnsed on the vur vcy pred iciions. hgl' re 6~8 shows the Influence diagram for I his 111"Ohl.ol11_ Tlus proh lcm can he expressed Inter In ~ or ;1 dec i sion tree. a~ ~1H)w 11 in hgllre6--c9 The "pper pan of 11i~ I, ec shows I he cicc, m'l1 proce.ss if 1\0 \U rvcy is taken. Thrs l~ the '" me 3nalys,s as presented in Table (, I 7, WI! h probabihues of 0 3 nntl 0.7 for high ilnd low sales, "~PCCIC(I prOOI of $(],2 million For unrorlucrion, ulld an indicated rlecixinn of 110 hnrnduci ion with $0 rWIII.~,

-L

fake

sUNey (or 'lOll

(~Ney

eurcome

-~I

I,

!IiJ

l'U,IIIU' 6-9 D,', ;"Ull l ree for I',-,.Ioh',," "" Incrn(i".-rlnu n]' New Pnullll'l

Cnr\dllI0n~1 ptn111 f~'''Ulo,,~)

No SUf\l't.:'v

[

H'gh saies rXLowsalO~

;]ij

Survuy Imllll~ IS Inc (lnr.I\J III '.Ie

02

-22

-02

The lower pill I or the Ir~L'. lolillwing rhc hr.mch .. I'nkc >1'I'Vl'Y," dl~rl~y~ the possi hle Sill vcy r,:,lIllS tlild III e SIJ hscqueru ,Ic~i ,inn poss i bil ill cs. 11111:1' each of Ihe Lh rcc possible ,0' vcy nUl()Jl1C~. J decision ilhm,( whether or no! In uurnduce the product 1111111 he mDde_ If !)I~ 1"'Hlllcl i~ inrrouuccd. the sales will ~III"" he high Willi U profit 01 ~1 H million. or low wuh a 105" of' $2 2 '"III,on. Note 11.1111 II", CO,I of ! he ~ urvey ($0 2 11111 hen) has been IIlC I udcd III I hc,c 1"1>111 "nell oss a m<11J 111.,

Determin ing Proba bifitics

J II order to ~Ollll'll'll' II 'C un o IY~II oj' I 'iAu re 6-9, w,' ,,,'col I he pmh~hil iii I~ s 1"01' rhe vanous even" Lei U~ suppo~c I h.1I I he markeu ng Ill.' nolsel C,I ,m,lIC~ liI<' 1." obabrh! I~, shown III Tnhle (, , g, These n I c the cond "1(1111" ['I ohnbrl It ie~ 1'01 the VIIII(\"~ ~I,,'\'ey resul(,1 ~',ivcll the potcntinl sale' lev~1 of' the pr!l(i"~l, For cx.uuplc , when :I. la'\» product 1M' high sale~ jlOI~IlIlUI, the survey pi ed,cl' success with I'lllh"hlllly o .t, the su rvcy jlll'd ,e I~ f",lure WI! h I'rnhahllny 0.2. 1111<1 III!' survey 110' rli he mcunctu ,I VI; wil h pmhllhlill y (lA. S uc II I'I nbul II]' iies woo IIII rcll !;CI pEl.II c:X I'I" I,' nee wi (11 "or vcys of IIII' I vpc. lI1(ld i lied per IHI ps Ily I he JUdgillCill or I b c mar kct illS 111"" ngc!'.

The prnbatuhucs shown on r "hl~ h '8 express the rchahrluy or "en,r.ll·Y of rhe expcrirneru. Wnh I hcsc es[i 111~tc" rhe marketing miln:lrcr can cvalume ,]1<' l'COnOiTIlC

<1'1\1111' (,I H

{ 'ulI(IIllu,,:1I l'rlllml>llil ic, "rS""I"'1' i'ndklil;"s, (;h'cn 1'011'",1;:01 S;llc'

I ~'j("jjl!.'~lllIl RrUj"L (IHI l'l"l 11, •• dr~ unllj

SUI "I.: ~ pu:(II'>. I ~ "llllC~";' ~S) t i c hl,j.!,11 ~llh'",~ ~ur 1h;'~ uH n~h III~I\,'>L:: t n

~"1 'C\ Im:'~I,(' fjhltlll.!' (t 1 ~ I ~~ I(H' ,lj·

()~ 0,1 !)

1.11

[J,I (ll O~ III

'I'i\I'U (,-1') .lni III I'!'Ohll!Jilily Tllllie

-----------------------------------

Mmgml./

IJj "'w~n!r/ll"l '~I Sn/.t.f '.~Llrl

r

I

tl J~llr~ljljr.1 L~I'd {II J,lllt'Y

1f,.~I, (/11

I '"\1 'I .•

f ---

I M(Pr,~ljllil Pl"Cj"rrIJ.'pfjf'~ n]

.}'j/l L'l"\' ,f~r(lit'rifm

----

.1''''''''';;-1

/'1.1 '''1(1 ill

/IJr WII Jjl~II'jl (Jf~~ F(H/UH' U j

I'll ,IIILI III /'1 r ..,d //1

1\1 .. I<lll Nt .,,011)

J _ I'f{) 1'1/1

1'(11)

1----

i'lL}

IH ,mLl I_I

100

f'(51

I"'.'."\~II'

01'

0111

II IY

\." I, ~ "I r-tl" tljill

'",,,,,d,,,,,,'''' 1 ,,,,',",",

1111 om,

() \~ n 2X

II ,II II \4

11..111 070

I.on

1I'0rili III I h~ mrvcy, Wi II1<HII I hcsc rt'l,ahihll' C,11L11Hl C_', Ilil 'p~ci fie 1'31 ue ['III ~w anne h~d In I al.llIg I he sur I ~y

I'II~ clIluhllnnal ponhahdn",\ of Table (\-1 H arc 11<,1 directly usefu] m hp· III C ("-!), l~ilLllcr, we I1CCU Ih~ IwrolU/iliorrnl prohuhilitics III' the various su: vey "III ~()III"~ (nll WI' "JIve availuhlc IlL o Ihe .\ur"~y probnhilirics cmuliuonal on. sales level). Wr ,11\0 need IIIC conduionnl prohabiluics of 8 hrgh ,11111 low ~,\II:S level, ):1 vcn ~ sur Vc y pi mile lion or ,U"CC~\, lInd so on

'l'llble II 19 IS a joint IlIllhnhililY ruble. The lor 1'1111 1)1' li,t: table shows tile Sylll' hoi" alld III,' houorn displHy, 1111' l'ljllivnlelll numcncal vnlues In the righr-huud ""1 ""111, WI' h,I~C (he origlll.11 prnnabihucs u"e,sed by I he ru.u Ke(i ng manager ;j 0 .i chance .h:1l (he product WIll have hll,h ~ale, (H) and a () 7 chance for low sale-, (I ) Frulll III('~~. :1 lid r rom the ~Clmll (I<1I1111 probab i I; tics of 1 lillie (, I H, I he joi nt prnh.rtnl iucs or Tal) I e (,-19 ca n he en lc ulnrcrl, Thu s. the jOI m ~rCl""hlli Iy of both a prcdic: i Oil of "succevs" by the survey (,II nnd hl~h level of aciun: lilies (1-/) is calculan-tl h,

These probahil i IIC; ;I ,,' culled p nstertor ['1'011" hi] i nes, si nee [hey en I"" II riC' the inr 111,;011 of I he ; 11 for IIWI ilill I" be recei vcd from 1I1C SII rve y The su rvcy I W'~ nll( been

11111i1 il'lyilig I he COII(lil i"",,1 I'mhabilily of ,I succcssfu! 1""~I"Clioll. 10:1 veil :J IIlgll lah~\ [('od (wluch I~ 04 I rum :1 nble (, 18), by rhc [1I0i1"hlilly IIi' II h'gh sakI 1""",1'

PIS lind If)

1'( SIH)P(f{) (0 .1)(0 1) 0 12

Surul.uly:

I'IS ;11111 I,) ('(I ,10<.1 If)

f{SIL)P(I.) P(lIHlP(lf)

(01)((11) 007

(0 '1)/() ') 0_1]

und '" III1

The nlargin;,1 prll""hlli( IC~ or sales level in '1',,111,' (, 1<) (11w riglH'hulld ,,,,11l11l n) ~I~ equal ro the sum 0.1 the jOint probabilities III earl1 row Note (hill Ihe,,, ruc precI'ely the Original prohahrliucs for high and low ~.llc~ and (hey arc dC'I!!Il,,,,,d Ild"'r jll'olmhi.l i tles bCCiILI,C Illey w", C <I,"cs-,Ccl bel ore "fly III for mat inn r ron I I he '"I '''Y WilS 1I111:1I11~d Tile 11l.tl'~II1!11 prohatulitics of ihc ,lII'vcy predictions M\' [',qllid 111 the 'I" i1 01 11o~ 101 nt pmhah ill III' , loJ ,'."eI1 col U 111 n

fn nndcr ctand Tahle (, .I <) I( " usef u I III (hin~ ,,1 II Il., I cprcscm i Il~ (he rc- ult~ "I 100 1"" I 'IWai ions Idc uncal In tile nne under couvulcrm ")II The prohalul II I r' 11",'11 1l']lI'c,CJIi (lie frcqucney w.th which the I'"no", Ulil"'ll'le, occurred. 1'111 C~;\IIII)I ... , ill !II 111' I he I 00 C~gCS. IIII' 1l~llI>ll sules for I he pl'nilllCI turned 0111 1[1 he hinll: uud 111 these ,0 high-,ak~ CilIC,. (he sur vcy ]lfrd'CI~d .\I1CCe'~ in 12 111 1111I1~l'~ I !h<ll " 1'( f I ami .'I) '- 0 121, W,I~ inconclusive In 12 111'111 nces , and predic red t.ulure !'l (, 11"""1I:e5.

T lie marg: na I probnhil il i cs or survey prcd iCllllll i lillie hOi (om [Ow of '1'; LI ,Il' (; 1,9 l" n I ben he rruerprercd a~ 111C I e I fll i VE r rcqucncy wuh which I he <u rvc-.y pre d 111:1 cd '\11<, resv." "rnconclnsi ve." and "Iailu re." respect rvel y For example, II", su r ,,~) prcil'rclc<.I "success" II) 1111101 100 lirnes-12 of (heM' (1I11~~ when ~,llc, ,'('(lIa.lly were Illgll untl 7 times when sl,ln WCI~ low,

'J'1i~'" rnnrgi n" I p,."hllil iii I ics or I U rvey pn'l I 11_'1 i 1111 .11'1' unportnn I 10 11L1l ,1I1I11.ySI v, f"r Ihey give u~ (h~ plllhilhilillC~ Jsc<ocoa(CU '1.'1111 the lIl/orma(ion rcrcrvcd by the !II." keung manager before ! he dccrsron In uuroducc (he produc I I~ made. rhe II,M 1\111.d probabil i (ic~ nr" rutcrcd beside I he apr'" 'I" II11 t, III''' "clic~ in Fi g"rc I, I (]

We ,I ill need 1[1 culcu hi tc 111(' probabl) il ics for II rc h 1''' nchcs lahele: I "II i gh sul c," IIHlI "Low sales" ill the 1011101' pari or Figure (, 10 We cannot usc IIlC I'HloI" IIf 0..1 nnd 0 7 for these cvenu ,I~ we (lid In the upper part or the tree because (hI "e pmhulnhucs were calculated .ndcpcnderu of rak, ng n su rwy The mar kc: In:; m.m "Scr wdl have received information 1!'OIt! a survey. and the pmhahrlirics should I Cn~,'! Ihl~ II1forll1JI ion, The required 1'1 ohahilities arc I he ceudinonnl probabilirics fnr Ill~ vur ih", leI cl < of sales loll veil (he 'U r vey res" I' For example, for the upper hi ,I nr b Or( he "'I ',Ike, II rvey" p~1 h. we nrrd 1'( H IS). the rmhahllny or )1I~h sales r I () gl v,'" • h,1l the ,III vcy predicts SIlC~l'\' (S), Tim can be COI1'PIII(:iI lillCt'lly frnm rhc drlllllll(lil of cOllilil i.IIIHI probability. 11~lllllllit lIllI" [rOII1 T~I1I" " . Pi:

I'{N and S) 1'(5)

OIZ o 19

()632

1'(I/lS)

Anll (lie probability of low sulcs, givcn I' .I~'lv~y IIIC<iicl;ol1 of SU~CC,l~, 10;,

I'(!.IS) = PCL and S) (>(5)

o III

o 19

0'68

Fl(aJltl~ 1,-10 COlllpll'll'l1 J)t'l'isiIHl1'l'I'('

-------

No survey

Survey P' ed'Cls

tanur a I 0 2 {OJ4}

o

H'gl, ,.IIIH.

~32) ~~~~snln'l (03AOI

COnd,,,,,",,1 P'O'"

I $rn IllIons I

S' 0

-20 o JB

-22

-Q2

38

-2.2

--()2

JB

-22

-0.2

Inuoduce P/(xhl[ I

Do no! IntlO[htCll p,oduCI

IntrOduco P"rudd'l':l

o ' )/DO M~lrO'I"e(J

f, produC1

In!roduco pf(1tlm::l Do 1101 InllodLJI:() prcduc

IIli"I., yct , b.n ihc CaIClIlHIICl'I\ IIfC bll~cd on the possible survey IC~IIIIS, 'rh undcrstnnrl Ihl' 1I1~lInlng of the .ihove calculauons. Ihlnk ag.un nf Tahlc () I') liS rcprcscnring IOU 1''''' idenucal suunuon« I hen. in I!) caw, I smce peS) '" 0 I <) I. the ~lJnc) prcdrcted W"~cS', And of these 19 '(I,C), 12 acrunlly had tugh sales result Hence, the pesteI ior probuhility rm hl)\11 snlcs I." as cnlcuuucd. 12119 = 0.632,

The postcnor pruhaluluies based on SIII\'CY predictions 01 "mconclusivc" ami "Imlurc" can be calculated surular ly:

.11111

P(HII)

1'(1.11)

O.(J(,
P(l/IF) IUtI
o 2K
I'(LIf) 0.101 0.12 fl ,17 o.rs 11.'17

O.2.'iS

(l7~5

1I.176

(U!24

i. ' ~

I II".

1"1';111(" II-II Hr,l" cd Part .. I' Dl'cI,loo Tree

21,"/

Survoy predicts

!.uc;(:cSS r I 6

/1019)

J Survey resun

fHke SU1Vey ~ 1\;~':c"-71-nc_lu-s,-ve l~ 2]

Survey p'e<loclS la,!!!_'e __ f021 10 3~)

Intf,.duCQ pro(hl(.1

Dn nn! Introduce nr(]C~tr,;.'

Do no' II'"WOdLICe pmtJLJCI

All I he ueccss.u y 1111 or Illation i, III 'W 111'1111;] blc, a lid Fi giL I C (, III ca nile ,\1111 IHed-~tartlng rrolll the right and working backward The expected value- .lft' s'llown In the circles lor example, follow 11111 the branches "luke vur vcy," • SUI ~~y p,cdlcts success." all\l "Introduce prouuct " lhc expected v:,I\IC 01 1.6 ,hown in the tilde at the end 0111""" branches i, c"lilllal~LI 'J'

I) 612 X J I! ~ 0 \c.H • I 2 2) - I 6

'l'lill~. Ih~ lit'lll 1:1111 ,'XpCCI a prnlu 01' 'hI (, million 11 the PIUtil1CI i, inl!'Cldllt.:cd ail('1 receiving II '1""'\' I'rcdiclion 0/ ~'ICi'~" Surce 11m 1< hcuc: than rhc 'to l 1II11110n assocuucd wuh nOI mtroducrnp 1111' product. the ,k""IIHl (0 mrroducc I~ mkcn, and the "110 IH'I uuroduce pruduct" lu anch IS marked with II In mdicnre III~

ruu oprimal. .

There are e'l'cclcd losses or $[1(,7 ,HId ~ I 14 (mcludmg survey costs) II the su rvey gives inconc hl~1 ve and Iailu rc preihcuons, respecil vcly In these cases, It I~ luuer not ro lruroduce the product. and the "Imruduce product" branches .ue marked with II.

The pan 01 I he .1<'''''lon tree rd,llng III I ilkrng the sur vcy " now reduced 10 I hal shown In FigLlr~' Ii II The expected value rn the circle !lOU,' I~ calculated as

I) I') '( 1(, ,. 0.47 X ( I) 2) I 1114 x (02) 0.14

Thus, rf the survev "Iaken and lilt' 1It.lnil~cr nets on (he h~'''!lr the ,nfonn .I",n received, rhc cxpccuil prolu IS $0.14 11111111111 Suice this is hellel than rhc ZCI'Il prnlu 11"'1 would he obllrl11!'d rlllill 110t lakillit the WI·VCY. il ,1,0111(1 11" tnkc II , NOlC Ihm II.1c dccrsum in IllIS COIl" " .1 <lrOlegy IIwnlvll1!, .I(IU~/ly IWO UCCI~""1' ;' decision no 1(1 t.ikc the survey, and the subsequent dCCtS111I1 In introduce the product rf [he survcv jlI'CciIC(S success hili 11111 tI, uuroducc II othcrw.sc.

2M,

The alue or Ihe Surv y lnforrnation

Summary

Tr,lling ihe ,III vcy ill the abov~ ~~lIlnllll' " " Ii,calll "i' 11111,1'111111' "drlilllHlfll IrIrnrll1i1' nun The mrm 111.11 ,un ,~ not pertcct because rhc \UfV('V cunnru tell c~aC(ly whether the sales will he h'gh or low. l he Ilcl expected proli: t nun laking II", '"' vey WQS ~O 14 111 ill i 011 , This included the COIl III 1111' survey ($(),2 million), and il' we II tie I back 11m amount. ihe expected value [rom the SUfVCY w,ll lit' 'So I~ + $0,2 or $0.34 million, We call th,nk or th" as the expected prom I mill a costles- survey lienee, I ill' vnlue of the imperfect infnrmut inn obtained 11111'1 the survey In tillS suuauon IS ~O,34 nulhon '1 he survey would roc worth taking ,1\ lling ~, ils cost did 1101 exceed Ih" .onouru.

l{ecAII llial ,',nllllli in the chnpicr W~ calculated III<' ~~pccled vnlue nl perfect lii/mmal ion (I'VI 'I) II~ $1.2 millinll 'lhe vulue of Ilw 'til ocy (111lpCfrCCI IIlfllllllrll ion) " -uhvranunlly below Clll~, rcllcl·tlllll the r;lct Ih~1 Ih~ vur vcy can give mconciusrvc or mcorrcct Inl." ruuuun as ,ndlcale(i HI Table 6-1 X

Taking " Sallll'lc ICPI(!'~I1IS I, 'IH11111S.,r nbtuininu uuuruuu ion This 1111'11I'111111ion ,s unperfect , smcc I he SH mplc " (l1l1 Ii kely to represent exac Ily the populuuou I rom wlnch II IS mken

DeCISIOn theOf)' Involves the chorce (If iI decision crucnon (I.C" a goal) ·s~y. maxtmizu expected I111JI1I. If possible lliitl leasiblc. an CXpCIII1l~11I IS conducted. Tile prior probabiliucs (Ii' Illc Slllle, or nm ClI" "I C revised, based ('11,1 he cxperimcurul rcsuh The e peered profit ot each possihlc dl'c"rn" is computed .lIl1t the act with thc IlIghe~1 expected pflllil 1,\ cilllscn as the ,11'"11111111 uci,

Hcfnrc undcrtukiug an I:.XIWIIIIIL'III, Ihr, decision make. nlIJ~1 determine whether rhe expected pmlil as\ociated wuh ilCItU!! afler reCCIVIl1~ the resuh or the cxpenrncm "wf~c,enlly I"'f~" In "rf:~cl rhc ells I or the cxpcruncni I'll" nnalysix rn""I\'C~ lindmg the optimum rille {which tells wh.u d"CI,~lOl1lo make as II Junction nflli~ cxpcrunental result) and cvatUlJlIllg the CXpClll',1 plUlh using Ihill lUll:

nal !o.is on Personal

omput °rs

AN illustrated iii Illi.~ chapter, Ihu", ~cll~rally ls only II II1()dC.~1 amount III l'alt'IIIHI ion ruvolved ill dccl~'{)n ilnalysis proolerus NOIIClhclc,s, !lICIC arc many \(If!w,uc packages avuilablc fur personal ClHI1PIIII'fS th,u aid In drllwlllg trees and influence diaI\rHlI1~. calClIllllIllg cxpccico v,IIIICS alit! EVPI, and will! II1i'lrC ad"'lllccd i'eIIIIII'CS, A 'C~CI11 survey lilled JO package», m;\I1I' (II which haw SII,d~111 cdiunns fill "',ls{)lIable pnccs I

'~C" Denne Buede. ~Idlllg In"g~1 II OIllM~ Toda" June I qq I '1'fl.1I of lh<<e .,e ~c""ral. purpose decision 'L"'Mty~i"'i I".ckages; "nfl1~ ~111 "pl!t.:li]r anatys.p;., r.;,m:.h iU. nc.~ ~m.tl[y(,i:'i LI~m.ll: MrmB! Carlrt rllelhod:-;.

!69

'nn .lusion

'I ills chapter h,l~ cilveted the II\~ of JlI nh'lhliil ius III Illllk'"g 1l1lsll1e~s ""CI:;IOI1' under Cllndll,on, III un~C'I,llllIY. 1'111.' LlII"IWn 01 I11~Xllll1l;III"1I IIr expected moucr.u y value w;r~ developed, and the concept III Ih,' I aluc of infru 11I;,lIl>n w .. s exanuned lntluence diagrmns and dl~nsl('ln trees anrl tlu-u \lS~S have hc(:n uuroduced. The villi I", nf rrnperfect informution Ita, ;11,0 hero illusmucd

The ideas ,II this chapter .ue 1II'l'or ram for I"'" related rcasonv I'll ~c, lonnal dCI; isron a 11~ ty~,,\ en 11 he used to d 1",\1 vcly '\01 ve 11Tl1'~' iii n I buss ness UC~I \10 n prohlcrns (see the DglclhOlpc Power ami Merck PIWI'1ll8CL'1I1,("d examples lind thc prohICIn\ at [he en,1 01 Ih,s chapren Hili perhaps mme nnpouant is Ihe conceptual I rarncwor k 1(11 1Ii'II~III!; a bou I dcc'~](1n, undc: uncert.uuty Much of model" hnancinl 111~t",y involving invusuucru llllllly'i~ 1\ hllill on rhc hllSI(' ILi[~IIS prescuu-rl IICI'~, lnven- 1111 y them Y 'II "1'1'1 ,1IIOn\ rs a nnt her III Cit I hill U 'C' Ih,',c concepts

The m311'1'1 II I 111 tillS ell, ptcr is e tended In ,uh"'(l"CIlI chapters flte next chapI~',I IIIlmclIlC('S usk 1I1Ii! ni her IlIellll Ii 111111 the (k~!\I!HI PllICCiiS, Oihc: t'll,lplcr; trcru iuvcurory Ihe"! y, sunul.uion. ~nd IjIIVIII'I[! iher» y Ihnl hlllill on decrsiou 1I11,00Y<IS

Hi hi iogra ph)

IIL'hn, R D .. and J. W Vnupcl Quick ,1 "nil,,,,, Jm IJ,H\' !),'rmOIl Mn"·f.' New York: !In'tc Ijunk\, I ~g2, lIell I) E., and ,\ \chh"h" Jr Dectsran Milk",!: under 1I1l1"t'r!lIlnl\ ('IIIIIi'1rII~e. MA' Cmrr~~ l'~chl1"lngy.

'"" I QQ~

Ii IlIWII, I< V:"\ S K ,II", end C rCIC""'" Ilrn "''''

1111'/"'1< 1m rill' A/"''''Ro 'CIA Ymk I h,I' 1(IBCI1llri & WrllllOII, 1<)14

11111111, I) W. A",,/irr' /IN'i.''''/II A,wly,I',.\ New Y",~, I\.IC(.;rllW· H III I'IH~

tJollowlI'j. C Df'll'-tOU J~1fj~'lng under Unrrruuntv Modd, (1",1 CI,I'I,"" LrlglcWOlltl CIIII" NJ' Prenuce Hall, 1')'/'1

MC~;lmcc. P. and I {clnlla Decision il11t'/YUJ I"" 'he l'mJcuiOlwl "'III. S"I'C' tree. Pilla A 11(1. (. II Sc,~nlir;c Press. '~8'),

l'ruct ice Prnhl .ms"

(, I, i\\\umc the (olll1wll1, ..,ndmnnal vuluc t .. ble apl'lic, 10 ~ <lCCIIIlIrl,

II /,

IIoSfl]Ullun~ (Of .hc"-r pwhlC"nl ... iHC gl";r;u.n the !o':ud or ,hiS (

t..:hllPI("1

l'rnu , J W,: H. Rnrffn •• nul tt S~hIH~rer. trw IIdll("/r(m fO \'fmilliL'111 Der uu», 'l'llI'nn' New YIII k IvkCi,'aw, Ihll 196:

1\,1111<1 II !JUl.';"" iI"III>", I~c"drng. Mil AddrwmW,"lcy Puhl"'H'III. I%~

I.\JI111'H1!l. n Morwgt'HOI u", BUm Anoh'~r\ I\ur t B I<.lge.

II R.,hard n IrwIIl I'IKH

Schhuler. R AlHd,\·\I.\ '1/ 1),'r:j,"(JII.\ wldll/" Ihu'f'l'lrlllt'y.

New Yl1I'k: McGI'rllv.IIIII, 1%9

SI"" /., .. , C S, and C 1\ ~w<'l von Hnl" ern

'I'rnhnb"IIY F"«"h"~ u Dcersion Analy'lS. ' ''''llIw,~r'"e,,' 5',11'/10', Nfl'ember 1975. ill' 140-~!\ '>ltl Ill'clSlOn f\naly'I' (it"'r!, Reading» '" IJI'rI.,im, 11",,/l-s,.. Menlo I'm k CA SIJnrollj Rc,.",ch

I nsntute. 1976

Cumlillmllil i\!nrwlul'Y Vuh," ur

P""lml"lol 'J/£I"('III

M,I

tIr, I

5 8

270

n PH~'it;'nl fL whh: of e.'" p-C I.: I L.':{I 1.1H"~I.II:r VjdLIC~ j"lnd dl'hH 11l1l1~ I he (lPIi m ... u .... 1

It PU"I'It."nl.1 ruhle 'VI" c..:.pcc.tcd I)PpUIII ulll \- lut;.,es ('OIl1~HlIC I~IC rom .. hllnn;li ~'ILhH' whlL' ,~"'~Ullllng.1 l~t~d~~Cl Ill'Ctllo;.:ll[lg de ..... 'C'(·

d, ('Ll11111UIC lhr- expected \',.hIL" ,.:-, .... LIIH.ng a perfect

pll~dlcllng de\ Ice

(' CUlllpUI!: (he expected \ .dul;' or pCI fc~: I mformauon fl 2. 1\ ncwsstanc 0rc-nUl •. 11 ~h:'--Igll'" f!luhiLhdl!leS 10 the demunrl fOI Filr.e magazuie :

E''f,jl PI"IIII!llhn
I )rrlltrl~tl /1/1,1'/'111
10 Ll1PI~"" 11111
II CnplC''Ii II 1 ~
!"? ("ofUC:ri. 11'11
1.\ COpH~:-' (J , ~
Iii Cf'lplr. ... II 10
II11I lssues sell 101' 50 cents ,,",I "'''' .1110"<1"

IP H the operaun ("lilt reuun lilly 1111<ir"lld cnpH::S fOI fLd' "'-It'du. how many :-..IWLlllj he' n. (h'i l't,l")

b If the epernior nm''''' return 1I111"ld copies. h""

"'II ny "'l';~_' shou 1<1 he ",.<lr,,'(I"

c. WIlI1I'~ Ilw 01";11111,," cXI"','II',1 111111;1 111(/11'.'

(. ~t 1\ lnJllHJ rJIC;l UI CI c,r 11:111 lOll rc I h l.ommkring.

p r .,.dUl:lluu of a new t\jljuht'Ij,\1Ilp; r he Il1l"!crucnmJ I'H Llhl " \ 10 ner IIml (on 3 presen .,llu" hll"'t, and lhe IICC""'" y 'IIVC.lmCIlI in "'IIIIPIII"III " ~~n(1,noo, The

csti ru;uc.~ of dC.I'llf"ll,dIS tiS 1"('11 I. IW.., :

)0.000 40_000 50JlOil 60,000 70,000

(lOS 1110 11211 n )0 I) lj

1011

rr .'>11",,1<1 the new pr",llI", I,.. 1',,,,1,,""<1" W hal I ~ the "~l'c';led 1'1'01;1"'

I, Whnl" lI1e cxpeele!1 \",1,," ,,1'1'"' reci ,"[0."'"''''"''

" II", ... "'nuld Ihe '"p,cIC<1 v!hlo "I perkcl

In['" m"II(ln change If Ihe pr(lhah,IIlY nf 30.000 IInI" "'0' 0, 10 "nd I he probnhlhl)' (,f 71l,O(l[J un liS wo.' O.lD?

(, ,I. l'hc Cnnpcr r.oll! CI\I1II""IY ((TC) O1ll,1 'k,"l<, which of ~h rce prno-UCI!o; In ru 1. oduur Bee ... usc of 11

vhm hl!:e of "'0, k<n~ ""1,,1011 "nl Y nne can he mrroducen 1 he II ~,II ken ng IrHHIIL~t'l .III!.· w ~III the dec rs-on ~ rce

.... llowl' Iii FlgLlre () I:'! S"PI~U"'1,.l Y'I,jll accept Ihi:-. Ir('t~ 11'1 n I L~fl!iiuI1JJ hie I cprcscm.ruon oj C{" ~ 's dt~CLSIOIl problem, and Ilw C(,C I< "',II!"~ ,n "It· I,M V a, the decision crucrlon

W 11m IS the or" "",I 'I 1,1I"~y [!of CCc. and whuris the expected pron[ 01 111" '"'IH"gy'!

(. ,(" 1\ compa fly 'I So trying 10 dec ide about ihe ~i'-L of 11. I1~W pl.", currently planned [nl Allama AI present, I he <.'"''1''' ny has only a nurnmul ",ie, efforr inthe loulhcrn ~I "'e" However, when 1110 /111""1,, 1'1 nnt IS completed. 0 mu [or prnmOL I on cflru l wll I h~' L~lldl,.':l taken. M n n Il~{, mcnt 1" ~(lmC\VIHH unceruun illHILJl huw i'.IICccs.;srullllis. r'Jrm[ Will I,,· II "C';lInl;lIcd 110,11 there I' " OA chance Ihlll 'he CUIIIIlJllIY Will CarIU," ,I ,",~"'.rlnIlJI 'hnr~ of the Illalkol rmd II 0,(1 Cll.311CC truu nilly n HlW'('jlW~ market shnrc ~v~11 u':'1ildl

i\ IfiI'~' plan! will he ''''"'kll If;J "gnific.nl m,,,k"l share I> realized /I 11",,1/ 1'1,11\1 would suffice [or the UH;ti'l'HHc cuse. The r.:~l"! oj I!H: large plant [:': $oH rrnlhon , 111\' ('0.>, nf [he small 1'111101. $~ nul"o".

'I 41 \,jIg n ificaru market !'i1';"'L~ materializes, t be.

C,llIl1dlcd presem vuluc "I ,e"J 111111' profils (exc l"dll1!~ «0,1 Ilf the plant] ,~ ~ II '1II1Im" If ,I moderate ,ha'e ,11IL1cn II II rc I, rhe pi "'<III v,.I,,~ nl I he resuh ing pmlll' ("1',""' ,,,eluding ~""I nf ure 1":1I1111~ f,H rnilllnn,

M I.nil~crntnl tUI:'i. one u! h.el uuernuu VI';: '1"11 is 1 So to ,,,,,1,1 a small plant, wall III vee I he ICIUII !If the ,''''lnnlion effort. ",,,I 111('11 ".",,",1 !hc plant If the ~II" nnun ","",1 nts. II "'lilli, I ~"" "10 add i I iona I $~ 5 1111111,", ", expand 1110 ,"101111 1'111111 Irl the capncuy "I II Il'l ~~ OI1C.

(I Draw ~I dccrsion IIC'C" tur !lw. problem,

b \Vhal decision should the wmpa"y make, and what

II> the e.pecle<1 vnlue?

~-(,. YOII are charged Wllh the mveruory CMI rrrl Jnb in II", Vnl,," ManufaclLJI,nll ("""'P 01' Y, You think Ih"I(' i, .nt'Hllll and chance of .1 reccvsum nell year lf there I!ii. 11 recesvion next yO"'. y~" 'h' "rill sell the A E4 ",,,<101 flOW 1'1>1'11," I nsr-offcr prier. III ~ I '" 1IIlfHI because you cnulr] ~CI (OIIIy $SOO.OO[J r"r II III " 1'(·,'",HI<111 year, Th~,c .unounts would ht: rl:tcJ'lo'.'jj 1'1 uw;~ yt::llr!h~we",cr. YUH

II n I'C n prom I,C from I he pu rc h;I'Ulg .I~ C 01 of J I end ml' ,'olllp"ny 10 buy the 1\1,;'1 1',,, ~ I 1 111111001' If Ihele I., "" '~~I'~SH.'" (" mOlln I pILYILIII~ rlBt'- yei" hence). A II"r '11111" lIu;liltLill,u '1l:alculallC")floiii. yew Mt: I"lill undecided III)OHI ,.1 I II1r, and dClcrml no Ifl ~"I her ,'vI<k"c" abolll , he

C hdlua: e~, or il reCt:~s.tnll Ill;' I )'e ill You d,scovcr 1 h.n bud <lehlS have been m"* rrcrmly i\ I,uk iO,'E""ga,, nn ,,"I,ellle, Ihal ror Ille IILII 10 I "I'c"ions. bad dc~I'

'I 7J

" ~,

"

."

2"

1"11,1 II!!~ (,-12 C( 'C I kds iOIl Tree (Prohlem (, ..;1)

----------------------------

Nmp'(l111 l$m,III"''"1

Time delay

5el ~ Ig" H 'll'l s. los

(~ CX~~~I~

(07)

Setlow IIlgh ,"Ie"

p~~e- ('YIO 51

~/ -, Low.a~_ (05)

,0

GO

n.s

[

" 0

(0.21

PrQd'J~1 A

(

So, high mg~~"a~
pneo 110
f ~"'" ~~- 0
108)
High ;ales _0
Pl''''' C-X1051
Low sates 2,0
IDS)
H'g~ sa las 80
~''''
C MOY,,!,-n58Ias ~ 0
(0,5)
LOw ~_Ie_. ___ 0
(0011
10 NO nrne delay

(0 B)

\WrlCO to mcrcasc approx 1I11d1~1 y a year early In "11'111 1II,lulle.s You are "',JlIn~ In "CCCpl O. S a< on "'IIIII,lIe "r IIII' 1'1"l1uol)' [y of bl,(1 (lel1" m "'g. 1>' vcn ,h"l " rc<~""." will uceur " year I ill cr, In rhc ~I""~ sense, Y'''' lilllllll:ll 1111 10 randornly 1~I~ru',1 ""1'111,,1 ycnrs , the oWrlolny

e ~ pc" enced nsi n~ h •• d ,kill' I he p,cv IOUS yeur on I Ii ree 1rI!!."'~c< Thus. you luk!- () 1 a, "" estimate n[

1'( risi og hlld (Iohl.' I "~cei>olon ncxl ye",)

I, YIJU tc""e your prim I" l1h"ilJIII,es "S ,hown .n lilt" cb"ple" whm w,1l ynu <I" "hnul (he AE4~

(,-7, The proo"billly ,,[ ,"'(1 <lIce. If Ihey ore fa" d,cc, !\i v "'g "'Ihe, a 7 Of "n I I , " 'A.. If the dice ,or" IOJi rlcl I

111 a certain fa,h'<JO. I he I""h"blilly of a 7 (II .. '11 I I " .... /I n acquarmance '''h you ,0 playa game w!lb hun If he throws " 7 or lIrl II, h,' will collect $3 r[OII11 Y"", If nell. he will pll ~ )'11l1 ~ I S .ncc rhe go me wou III )',1 V<' Y"'I 1111 ao(lvFHHa~V' I'r I'll;: di~,t~ ~!CIC rjllr, you hnve !oo.LI"'lHC"IIIU"i. "h!lUI your "cqll,IIIli,IIKe I n r~rllcu 13r, you h'" I I hal there IS 3 0 7 chi, nee Ih;)l. he 1\ using load~d die,' "III. I"Uhllblll1y'ftJ rOJ" 7 or II 1(. 1l11~y you, k;o(~, Y'"'' nl!I'onenl orf"r~ 10 le'l yo" 1'\111 II Ie dioe I wicc Yo" (10. ""d you do nOI ~el Il 7 'If lUI II in oil her o[ Ihe I wo Ihtow,_

Should you rillY Ille gM". Wllb yo",r ne(llIn"U,IrI«" ~how you r cok,lI,lIlol1'

272

6-~, Reier to the exarnph: III the ,'httpt'" a, shown "' "ll(nr~ (, I) lind Table 6, 1M 'i1l1'1'1". Ihe reliab,IIIY (11 Ihe lI10lrkel survey was de""hc:d h) rhc rollowmg ~Ol,dltlnilitl prnbabil: ues

"'fInal Lerel of S"/,,

Survey Prt!dirtlfJl4

l ... nw

Success lnccnclcswe Failure

rp 05 OJ

10

III

['roblums

(, 10. An analysis and force.,,, 01 nnl month's sale, result. 1M the followmg pmhllh,lot y ,I",,,h,,,,on

£vtrrl Demfll1d

10 un", I 1 'Iml~ 12 unm

o 10 lUll II ~II

It~1

Tile Ilmlli per unit 1< ~l I'IH' ,'ml 01' II,c product

,,,1,1 ,,~{J If the product " not sold durtng the month " " "(1l1hl~" (lefrover unus are 01 nil value),

IJ, Compute the expected (mean) "dc, for rhc rnontb

IJ Prepare" table of cnnrh t I"nlll V~ lues for, he di ffefenl po~,jhlc :tCI"

Pu:purc II (able or C;r;pc.l'lC'd Uluu'~MV values nnd ,,"hCllle the opumurn .lel

I> I I, (COril muat ion of Pmll,"", t1 10)

n, I''''IIIHC It table of conrhuouul oPI'Ot'tuiliLY losses, I, l'rcpare 0 table 01 exp~clcd 1'(11'0' umity loose.

Ind,cal( the opumum ,It.

rI Rilf!k rhe nets. Show 'he .hll<l'c".c, between Ihe r.~p(:clccl opponunuy In~~c~ of elicit net and the EOI. "I' I he tlpl, Il1UIl' act.

~ Rank tile acts. usrng expected vulucs Show the

dl Ifcrences belween Ihe eM v til each aci and I h~ liMV of Ihe op!lmum aCI, t"mnpllre these resul!, ","h Ihose of (dj,

A"'''T1j,,s all 'he 0,1"'1 lttlOllllnllllll in [he e"~",pl" i-, Ihe sumc, should Ihe sur\ICY he I"kef!'

1,-'1. Reier 10 the ~~anllll" rn lite cbaptce as ,hnwn 'n "'gmc {, 10, Assume 111111 IIIC I"(llil,' arc as given In luhle (. 17, and the euruhuuunl probabilities ns ~iI"'11 III lublc (,-18, However, nOW n~SUI11C that management's prior probabuiucs nrc 0 S lor IlIgh sales and () S 1(1' low 'ale',

", W list IS the cpumu III lie uon before constderaunn of a survey? Whit( is Itt" c~l'ccled value of Ihis act;nn'!

II Wh.u is me expected value Ilf Ihe survey mfonnauon?

{. 12. Refer 10 Prohlem (, HI

" r'rc,cnl 'he conditional ',IIIIC 'Ghle. assurmng n perfect prcdicung iI~vt~e

h. C:o"'r"'c [he cxpccrer] vIlIIIC, ussurning a I,effect

III edicti ng dl'V1CC

r ('nmpulc the cxpecie .. value of perfect mforrnanon " 1,\, A manufacturer III 'purling good' nas the

1111 I <110 II1g demand unrl I'rohullllllY schedule 1m ., y .. lllly Ihltll,g gu ide ma~illlll~

L!jj'trr 1'IrI~w~tdir v
"('Ijlrl/rtl ('1/ f:W:'H
roo t)1111 020
200.000 11211
.1011.000 om
"(){\,aon Q,IO
51ln.ollil n,IO
I tin rim lncrcrncmnl eml, of 1"'I(hlcl ion Me $400 pCI' 11,0"'(1'1<1. lite ,ellinll price I~ ~~OO per ihousuud, IInr! II,.. salvage value of unsold nlll~i11InCS ,~ zero.

" I he manufacturer rcu'on~ 'I' follews: "SUICC shere " ell cal chance of de ICI II rul h"mg. Ie" or grerue: I lilli' JOO,OOO. I siroll pi mlm·., the Iml~1 likely 11II'(Hlllt, !OO,OOO," Do you III:ICO" II' nOI, why 1101'

/. Whal is Ihe expecled ".Iue r a perfeci prediclu,n'l (1-14, A real eSlale InvC~lnl own~" gasoline ~talt('n 'he h"h loused [Q a major oil COm plwy fur a remal Icc b,,'c(1 1111 " ~har" of profits, I r the ~lllllOn is succe'.,flll, the

!7J

P""CllI value of IU,.IIl' "'111111', I, csurnnicd '" $1 mill"", It lite ".Uon ,s nOI '''Crt',,1 ul Ihe pres"ni value 01 che .en(al, WII[ be ~201).(ln(J lhe ml cnmp"ny I"" "r .. "'II tl,e tnvcsror $(,0(1,0(11111\ I,"y Ihe proper ty ouurulu (Ill 1111 expuctcd 1110llCIMY Vlllw' hll~", W'l"' l}roh"blhIY would need to be a'''glll'<l1I1 "success" for the II1I'CII'" 10 he Ind.ffcrcll' nC'WI"'1I srllmg and not sclhng

(.-1 S, ,\ book'tore "" nc I c.nl purchase 20,O()O 01 ,I Imhllsllcr', leftovers 1111 ~ 2 50 per copy. By run k "'g '''1' ul urlverusing in II n.1t!oll:IUy thL;,lnhlur:d newspaper: he I'''pes CO be able 1(1 ,cll the """b lor ~ 10 pe: copy

I .eltover hook. ran be ">1,1,, I per copy 10 Olne. "':I.ilth::r~ 1115 cq I rn.ue 01 dt'rnund III.;

l"ol",I,Ui(\I ", """~lld

j,II~1I I(IJ~)II In non

(J,IO [),50 II ~o

100

The co>! of advcrtivmp I~ ~('II.OOO. and incremeuml ~II\I' of slllpping ,he h""k' th,ll are sold arc $1 U 1'.' cory

n Sh",d<J the hon,,,,,," ,,""C I purchase I he h(1o~, I

Ii. Whll! is [he e~I""'I('d l'r"~1 wub a perfect 1111'lllctllll' device?

Whot IS 'he maxunuru "",nllnt me owner ~hould !,I'Y lor perfect ,"((10nllllOn'

(.-1 (" Whcli a new ,1101'1'1111\ center is burh, ti,e elrcuu [:HlIII)~lI1y must .FHiS1V,U II II ~1B~ftU'lt-H.!J' to tile. locnunn Since this is done betrue the occupants or Ihc sh(lI'IIIIII~ center are kno" n. Iher. " uncertarnty about .he ..,III1UIII of CICClrtCIlY 10 be usc" Ifllr exurnple. beauty 'illnN mc milch more electncuy III"" "'Y stores) and hence, uncenuinty about me ~,,,. of lite transformer needed A '"'' ,,"nil transformer ,"auld hove to be replaced. und nne 100 large would re,"11 m more expense than nr.oL:(!.§.S.1ry. A table glVIII~ Ilu''li.f' Co .... l:'; IS showu helnw

",tt n/TI'(wfjmHII"
O"XIJInIl} 11,,,,,11,.,1
~"jlflLjlll (~I Clt."CI"CU\
1II/jrlwlrI)"II('("(it,r/ S'lmfi M~rlr~t'jl J.II',frr
----
Lillie It I 100 1\0
Medninl HIl 100 I~II
M"ch I'XI 190 1<0 Suppose. [rll it)\' ven ',IWppllig center, Ilw I nlill," 1"1: 11f{lbabillUe~ MC ,t"IJ.!,flCd In the nmuunr of dl'l.:tt .flIY ulumarely ncedetl

Pmbobih/ll

Lu." Medium Mu,'11

OZ 0,7 0.1 1,0

" Draw up DI~ OPI'Ullltrllt)' I~" tnblc.

/1 Whm decislnu ,111111111 be Imide? Why')

WI,31 ,< the I'XP"CICtJ v"'lle or perfect rill", ,IIlIlro(1' (,-17. Ane. CnmrUIC" ha~ contracted !Ud~h""r "'" model X-60 """'rull'l '1""'11' Itt" J"p'"'C''' uruversuv l'hc terms cull Ir" Iii" 1"IY"1cut "r 1)0 milhnn '"I'IIrt1'W YOIl to Arte~ nil ,J"llv"1 Y IIf II,c computers ill SIX

months The cu. feOI .><hange rate is 150 yen It> Ihe dull" However. (here I~ ,PIllC concern In che hnllnCl~1 markets about the f,,"tre \'"I\le of [he yen Thl', I~ reftccred in the currency future market In wluch yCH "forward" vix rnunthv ~'IHl he bought or "iold tU u.e I 'e of ISS yen 10 the 01 .. 1111, In pas ncular, Anex can ,~II ',ho,," the I ~O IIlIlh"I\ yell and receive $9('7 7(1(111 'i 11"""," nnw, Tho ueuvurcr n! Artcx hns rtlsiW~t'<1 lite [nllow;ng prnbnbil i I ,CS 111 inc exchange rill" fr .r yen In '" mcnths

I', U ilwl.llt' Hwf" (VI'" ,WI' Ilo/itll'J

I ,HI I ~II IMI 1111

01 0,6 Q, Q,I 10

n Assuming tltill AI rex I' willmg 10 ",. I'M V III tlt~ decision criterion. ,ltt",ld II scll the yert '1IIIr'l or ,","l unri! payment " le( ervcd In", month,"

/1 Poc, I, tV al'I)('.II ,II h. ,I reasonable eruer Inn"

ilns pinbleru"

I.-I H. A corn pany oW lIS II lease gram I ng II t 11<' II gill 10 explore [nr oil on ~Ctl11l11 property. II mny ,.11 the ICII~e fllr $75.000. Or II IIMV 0,,11 fM od The fmn I",,,,hk dniling oulCO[l1e' M. It'ted hd"w. IOge,hc. Wit h pruhabil i[ le~ 01 oc(:", H'rlce: Mid dollar con~cqLJenl'r~

2711

rmIJNJIUI"JC~.'r
f'rJ,uJM.: V~lr,ojttt P 1",0 IHl'~.I, r ~ (J jlrotj,\rJ~ld.'i J
D,'y wrll 0,16 ,00
U .. "'<II only o ~O 210
Uti and g,jJ1
com hln.al ~lJn 02· ~OO
0,1 ",.11 Q 20 l,l1(J(J Druw • drC''',on tree for I his problem ,,10<.1 compute I he expected mOllcta,y va jue for the aCI 'd"II" Shoultl rhc <I1"lr""y d,,'1 or sell tho lease?

(,-1'). Tile /Ill{ I'rLl"""!O~ Cornpnuv II," II",

Oppfll' I ~111i I ~ In !lIlt ~111 IL "su re ri I e" III hlr:llr. ~Ol1lo!,,:.~t 1111'"0"", II III II 111'. rhc g~I11C can IWI I", 1"11),(''], If the I~"'"" " pl"y~d, the fi,m "nod, 10 1101 " unllum If" "UI1<, Ih. linn "und, 10 lose n,,1 "f I~",h·t (.ml "1'1""'''"111 Y <11'1i S I million Thet C " " n ~ I "ohufotiOi y 111 rj[ III II wjl n(' I~ knew whether or "", 1(1 buy

I nsu rnncc !lJ;ums,l nun.

[J1;oW " decision tree, How much could rhc 11,111 pay for insurance (0 COVCr 'he $1 m;lllon l(»~ and he no worse off on nn expected value ba~" limn I r II did nul huy IIl:r.,LI rnnuc" Shmlld i [ buy 1 n:-;.u r.1 nee LII ~ h~I' price?

( .... 211. T he 1'111\li<: Product ion Com l,allY ""I,d, 1('1 expand i I< 1'l\"lll~( ,0" cnpaci Iy_ This co II he rloue ill Me 01' I wo wHy.... U:'rijjll~ ove. lime: in its current pJ1l111 Or :Ic~\~:A ng

,I not he' pl., It I 0 '0 11 ;me has ~ CO~I p"lml1 y .Ih",," rcguI.1r lime) of S] per case or I'rodllCI I'r, .h'te,l. "Old ellll ""I y Iw I"od [rn up 10 15,000 C''"C' po, Y"" I, I.c"~illl: 1111,"1"" plnru would crnnil nn uunuul lI~cll Icmilll' ~"NI of $Z5.000: however, Ih~ work 161 co of 11m pi" 01 would bo p~,d on a regular-rune hll'l' .'m.l cou 1,1 produce .oilY numher or cases up lu a I1U,X.lulurn u[ 20,OOti CiI"" .innu.lly.

The cornpa ny est i mates thai odd Ilin"lIl dCI nil nd (b~YMd whut cun be produced in ,I., "1J1'1'",,1 pi" 1\1 IT' regular lime) I1'1"Y I, ke on the foll"Wlll~ val ,,~~" willi COl r<\rnndlll~ prnballl];1 Le,'

Add,11 rOIlfJI ()cmnmf (.(';IMI"I flU ycurr)

5.0!J(] (0,000 (HKlO

(J Dr •• w .1 ,Je<"iOIl tree for this preble 111 •• nd I; nd the OP( llnal deci si no to rni n irm z~ c ~ pee led C'N!

" S"pp"'e., 11l~1 hi rcscarcl .. comp.1"y ,>f[r" ,,, perfnnn " survey (0 delcrmlOc the .. nel 11"..rlmy

of "<i,llllolwl de mnrrd ihm will be fUrillcIlmlrll',. Should the nllnp"ny he willing 10 I'"y $I,tl()[) lor such " pc I foc I ",,'vcy'.' Why or w h~ "01" W luu i, rhc expected "ppn, III1lHy In" (EOL) of the hest dc,,,,,,,, In (np

6--21. TI\l' QI'C COin p., ny is deciding whether to

mar ker W()d"~1 /I or IJI'oduCI S, The (Ieei""" 'Iel'~nll~ on 'he .'I'c~ll wiih which the disrribumrs ",'~el" II", product nrul Ill" type nf marketing >lr~lc~y (prumouun M "d\'erll~lnt:) employed by QPC. The c"mplln~ I"" diagrammed ,(~ dec","n problem "' ,hllwn r!l ligurc 6-13 Til. "11,11 Ih,w, ""oc,med wuh I"" "'1111'"

dccl~ II )11:'1 ,lllld uvu .. l!·, J11 C shown fH lilt: cn(1 or lh~' II'''!!: branches: /1,",",," Ilrl1l \,,11'[: is willing In U'C I~MV Ii' rr:i.)k e ~ I hi \ dCI;!\ lun

" Whol I' the "I'" mal '1'"ICt:y fur Ol'{ "tld wh.11 I' 'he C'I"'Ch"',.I''' 11"" for tho< ''',I\e)\)''

b. SUPI""" 11,.n 1)1'(' 1t",1 10 make >l <1.,"",,," llhmll 11.0 I ruu k"1 iug ,II ""'~y (promotion or udver ll" "HlIJl.:/;" (' n ndlllil nu I ;,1"),, l the speed of 'he d Is'n hUI,,, " "CCCplance" Would this mauer, and would the

opn mal e ~ pee I ed cash Ilow be reduced? W h) ~

A nswer WII f1nul tcdmwmg (he tree

6-22. 11 <"""'I" manufncrurer produce, 111'1> rnnde!s (~I>lndFIr'l1 nnrl d"'ll~e), I" preparation for the hcnvy Chm'm", sell i Ilg scnson. product inn 001" ll1e, "''''( he dcrernuned V.tn.,ole C"~I (If Ihe <lamlll!' I 011111<'''1 I' ~ W. .lnd se ling price " ~20; vnriable <0';1 of the ddll~. model i~ ~2(), "Fld 'clhll~, price "n~ Dc III ," "I II CSliroll""iI r" f"ll"w",

DemlJf1fJ

D~m(Jrld

0,.10 1171)

2,000 ~,OOIl

020 Il ~O

Any c:aIlH:r.l~ nnt 'i.utd thtr t ng I he Ch rlstrun., 'H"11 "'. Hl nrc sol (I ~I ",'Vlll:C puce orf $5 for me ~1I",dllnl lind ~ I 0 f~r Ille (Id"~,, """'e' TIl<' mnnufucturer IlIi"k' 111111 diffe"",lI "'1~1II"11l' "I II," mar kc: purchase lite rwo

dl [ferum models. thus, she probabiliues of sales j\IVCll above Ill. lndepcndem

S"PI'O!O J"nd""llIlll capaciry is unhrnued. '1 hen the I wo decision call he mild" i ndcpenderuly W 1"" ;ll'" rl", optimal (111;'"lil"" of ouch model 10 produce" WIIlIllrt'C the IwO OI'I'ITl;" "MV,'

ProduCI s.[I'e:-.II1'Vnl

DISlnbul0r acceptanco

InlrOOUCQ

Ouoc~ (03)-- L

ProduCI A

Product B

<?u~ 105)

High P'OI"Ollen~

I ~'"

k~;"~) (06)

Htgh Adv~n,&,ng {VToli

\.~

(031

!15

Cash no~ (Sm,lhons'

9

7

-3

7

-2

-4

5

o

4

o

:3

276

(,-23. (Conunuarlcn of Problem 6-22) Now suppose Ih~l. due 10 capaciiy consunirus, 1()IHll'rodliclion IS hruucd to 10.000 cameras. C('III;1i'I1C1 il decision tree for 11m situation. and analyze ,1 10 obu .. n optimal production quannties til thIS ease.

6-24. (Conunuation of Problem 6-22i Now "'I'I'0,e II"" production is limned [0 11 1010101' 10.000 cameras but that the manufacturer now thinks thai [he.

probani) i Lies or derna nrts a re ItO touge« uidependrn! for [he I wo model." Spec: hcall y, I he accompnnyi ng JOI ru probability table descnbes tnc probabilities of demands

Construct a decision u-ce for this ... ituaticn , and lind Ille npiimal BCI "'10 il> E,'v\V

.Ioi III Prohllhilil)' Table

I~)d''''['

{)crrrfrild

SlnJlffal'ri

Df!IIl(lrul

MrJ1',"!ltll,1
!lmiw/JiiUl
(1{D('"mwlrl
1.O(]() 4.000 [or Sl(JiJda,·,f
0.,0 11.10 0)0
D 070 O.JO
lUll II.SO 1.00 6.noo

f-----.-~- --;-----1'--

8.0m

Mm"grlU'lI ?mlmhili'" tlf f)(,JJltrlu/ !(}I' Dt!h~·f.'

fi-25. The Ch:eIH.,1 Company uses n,IIUI',a! ga~ !n it"

prod lICI ion processmg opera! i ons. Nci gl1buri ng companies III m:. ~JPSlaIC NC.!w Ynrk CIrca IHWC

succe ssfully drilled for gils "" rhcir premises. 1111(1 (l,'~"ClI rs considenng fnllmving suu. Then 1I1il",1 expundnurc would be 1'01' rlrilhng: this would CD" $40.000. lf rhcy suuck gas. they would "ave 10 spend all addirlonal $30.1)0010 cap ihc well and provide for the necessary hardware and control equipment. At ibc current price or natural gas, if (he well is successful it will have a value of $150.UOO. However. if the price of gas rises to double its current value, a successful well will he worth 5300.000. The company thinks its chance of finding gH, is 30 percent: II also believes that there is a 50 percent chance that the price of g"' will dou blc.

tI Draw ~ deci'lOn Iree for Ihis problem. Riling in Ihe jlt'Obnb;lil ie, "nd val Lies.

1>, Complelo [he trce by calcuiluing eM V~. Whol

shnulcl Ihe compnny do?

6-26. You lUll.>! bOI on " 10,$ of " coi n or u nk""'" n physical characl.rlSlies. The coin is lossed by a

moch inc. The dccislOn YOli have [0 make i, 10 bct heads or l~lIls.

II ssu me I hm Iii. pllyoff, are described by the rahlc below:

HC::Jds T,~,

+ lOa -400

-100 +100

Your prior judgment rndicares Ihlll yo" believe Ih"1 there ;5 A one-half chance that rhe coin 10 be tossed i< fnir (i.e .. has II 0.5 probatntuy or heads and a 0.5 probabi Illy of I "il ,1: further, you be I icve Ills I [here is I' ol1"·fo,,rlh chance that rhe coin is rwo-hcnded (no chnnce or tarl): and frnally, you believe 11<<11 there i,,, one-fourth chance ihm rhe coin IS two-tailed (no chance of hcnd ),

YOLl are given the opportunity W experiment before you bel. The col n will he tossed I wice. A [ter obscrvi ng the results. you will be required [0 bel eilher heads or [t-Ills on l he next loss.

a Suppose both cxperi menial losses came up heads, What decision would you make (i.e .. wtwi would you bel on the next lOSS)? Who. is the expected payoff?

h SllPP()~(! 11"Ie! cxpcnrncntal tosses carne 01H with one i1ca,1 nn<1 one tail? Whal would be your decision? W nn Ii, the cxpccrcc payoff?

Suppose IWO IFlil, resulted? WhHI IVI",I,I be your dccis.on? WIHII is Ihc expected l'"yo(l"1

d. SlIl'I'U«' yrlLl hnd " chorce of playing or "(>1 plnyitlg Iii [hi~ game (befnru the expcrirncmal tosscs fHC flipped). Would )'0" play? Whm is the expected payoff of playing?

6-27. The LJ VW Music Company makes music boxes for a variety of 10)'S and miscellaneous products. UVW has a gl.laraoLee on its music: boxes against breakage for C1 one-year period.

The sale, manager was concerned with the number of m usic boxes that were being returned under the guarantee, He thought an cxceSSn'c numher or music bo,c, tl1m fail LO IJst one year' would di1l11oge Ihe image of " q~1 nlll y pmdLlcl thai U V W wn.1 I ry i ng 10 achieve. On chcclong, lie fOLII1d tl1111 npproximalcly 5 percelll

of Ihe ",,"sic h~"cs were relumed for rel,,,ir wi[I""

tOne year.

The Pl'Oduclion manager silid [hal [he trouble in almosl e .... ery Ci:l::;'C waS <3 nreak III a crucial spring mechanism w;lh,n Ihe music box. U VW was having trouble ohlaining a spring Ihal was emirely salisfaclory. There w,,, il special alloy Ih~[ cc'>uld be used in Ihe

277

>Imng and would guarnnrcc virtualty no breakage. II ,pring 1113dc or special alloy would cnxt $2 each as opposed 10 the COS I of 20 Cell IS for the ,Pl'll1g currently used, Tile production rnnnnger did nOI [eel IIIC incidence or I (nilure 0111 of 20 warranted U51l1g 11 1,IIrt 10 urncs as expensive.

The production manager added that In the music: boxes th;_ll WC1'C rctu rncd W~( h a broken spri ng. I be special-alloy spring was used for the repair. so iha: II second breakage w,,, extremely unlikely. In addition, the cost of 1111 ndli n& 11 nrl reparring a box with a broken spring was $13 plus the $2 for rhc special-alley spring.

Tile sales manager argued [hal the special-alloy spring should be used in each music box. He fell that in addition 10 rhe dirccr COSI or rcpniring a broken music hox, there was a goodwill ~O" of I'OlIgl11y $5 every lime a customer's music bl)~ hroke,

The deCISIOn was nor a Irivlal one. since U VW ItiI(1 eSI; milled sales of 20.000 music boxes over lite "ex I year,

(1. Which alternative should UVW lake" b. W hal is I he EVPI'

6-21!. Refer 10 Problem 6-27. An alternative action is suggested by the U VW chief engineer. He has been approached by an ins: ru merit manufact Ll rcr with a test device thai could measure the strenglh or the spring' currently used ,,",I "II whether each was "strong" or "weak." lin experimental progrr,,,, was introduced in which 100 springs were classified "~ chhcr strong 01' weak and then PUI on U VW tnUSIC boxes. The boxes were I hen pili rh rnugh It process ecs ig",,(1 If) si I11U lute abo". one year's wear. The results arc shown below:

Results [If Test (If 100 Springs

Tcsr Acr~wl [11/11Q'vlOf'
Df:viCI'!
Prediction Good Dcfecuve Tnlal
Strong 79 80
Weal< 16 2Q
Total 95 100 Th" produciion "'orulger uid 1101 Ih,nk Ihe leS! would IJC useful. He nmcd [hra f'Hlr good srrillg, weI''' rCJected for every bad one Ihlll WllS delected, T'urther. Ihe leSI

did 1101 elimin"le "II (lereClive .IPI';11£.'.

The chief engineer Ihoughl Ihe tcSl woul<1 be cconomicall), feasible. I-Ie nOled thai Ihe cost of Ihe equipmenl and other cosL, a"OCi"ICd wilh Ihe le.<1 device would amount 10 abolll $4.000 for I he next year.

The sales manager ~Iill preferred using all special· alloy springs but would accepl us i ng Ihe [cst 5i nee. as he

noted. il would reduce the number of dcfccrives 1(> about I percent.

Should U VW olnain the ICSI device <11111 usc il 10 screen springs'

Hint: Five springs need 10 be rested 10 g~1 fnur Ih.,( rest "strong." Hence, I he cost of a lest "strong" spnng is V. X 20¢ - 25.

6-29. Refer 10 Problem 6-18. Su ppose " [cSI ca n he made al a cost of $25.00010 determine the Iype or underground formal ion ([ypes I. II. Or l l l): The underground formation is reluicd 10 Ihe type 01' wcll. hUI the relation is imperfect: or 25 wells selected at random from sites ncar our well, the following table iltustrate» histcrica] OCCli rrenccs o! well type a nd underground forrnauon.

Historical Occurrences (25 wells)

~ I II //1 Tm,,!
I l-
Ory 4 0 11 •
Gos I <) 0 III
Gas, oil mmbinll'11Ofl 0 I> (I 6
Oli 0 0 .1 ,
romt 5 " ) 25 I r the 10.,1 Is made, and you subsequ entl y decide not 10 drill, yOLJ can 110 longer sell the lease for .n5,OOO; your prospective purchasers will conclude thai since yo" decided no' 10 drill, Illey shou Id nOI .. lso, so I ~IC I ease will have zero value after a "ICSI without d"II"

outcome.

Construct II decision tree lor lhis problem. Should you sell the lease without resting, drill wirhout testing. or test? lf you decide 10 test, under what circumstance, will you subsequently drill? What is [he maximum EMV?

6--30. The credit card manager of a commercial bank

rn ust a pprovc or reject appl icat ions for the ha nk 's credit card. She CllrrCfllly use, a "scori ng" procedu rc whereby a series or cllarllclerislics ~1"led on [(II indivi<lulll's credit card applicalion are wcighle(l by predelermined numcrical welghls, Based on Ihe lOW I weighled score,

un upplicanl is cia.<.,ifled either "good" or "bad" accor(ling 10 wh.[her Ihe score exceeds Or foils below Ihe l)redelermined cUlorf score.

Recenll y. I he m" n,~gcr has been e"n~ idoring "n al[ernmivc procedure wllercby an applicanl would be rejecled if Ihe ~C()re fell below a new "low cUloff"

27H

,,'ore accepted If Ihe core tclt ancve a new "11I~h <Ilion score, and InY.SlIgllled fun I"" II II fell III 'H'I\."it'~~n, !tFllrlhcl 'I\Vt'~'jltHIIOI1!' Invnlvr.~ an t'XlCI1StVC CI ed" ",vCSlIgaliol1 III .1 ",,,I 01 'f.SO ""010. Av"I.Ihl~ dOl'" 'lit a, shown In the ... ·wmp."'y'ng ta blc' I I he Vcr~ 1(",,1' nnd "Very hml" grmlp~ are detunuiuerl fly

~COI 111[\ nlcne ; the other IWO groups RIC clr.I,'llilined OIil('1 (he credu bureau check)

I he hank has deter nuned that the present vuluc of r"IUle Jitofir for an npphcnm who "pays" IS )400. nnd

1111' I" c'rlll value o[ II,,· /", "., ",currc(1 hy .11, "I'plicanl ,,11(1 "(lC' nOI P') " \ J(j(j

" Ill"rcl 011 uic ablWl\ 111I1I11111111(l11. rs Ihe l'ro(l,,~cd ')"".", In be rrdl",r,llu Ihe current 'Y"I'''''' Why~ 1·01 I IWlI) apph(.lIn\. whal " rhe rna ,,"""" I M V .Il pt L· ... t·rll \'.J I uc tcr m~'~

/, III ""I,,,' In improve 0" 111(' current system nhove. wi,.., Ilridnion.at 1l1rtllllHllinn would you like !n h." .. e? l low rmght Ihos mfor 111,11 "'11 be obtained III ,KIIIOI pracucc?

Currcut SYl.lcm (resuus lur I,noo appli a"IS)

IJflr',\ 'lJ"II'r;\'

~.l'I'J

'(10

1,(llln

1(111

'Cllnl1UI drlr.rnun~ pLl~me.n. pe.rlCl'IH1lfWf' nl t h .... 1(1!" .npf1!lum\, Whtl~!:, L'll~jllr~IJon~ were rClrCled

PrortnSI'd System (cSLiIllIlICII result rOI'l ,UUf) applicants)

I
f)hrl
Nml',l,I' Toral
In .00
1m 2;0 ------

Mort;' Challenging Probl('ms

6-.11. Evergreen I'h"rmaccul!cal Compony " nmlc,nplH\ing an on" ,Ial,on 10 ,n"CSI In Sw, Ilip I1m\ech. " tnllll"Il1Y engaged in ,c'cnrch IOUI mny Ullllll'llCly lead

10;' d,"~ cffe~livc for reducing proSlalC pmbl."" III ollk, rllen. Sla''''r need' money now for RIO Il. ,Mre m(lIl~Y on " r ew YCMI fm eli nieal I ri/ll.~. 111111 fllmll y

279

money fm processing equrprucru in SIX or 'eyen ye"" In return, Evergreen would I!CI pari owncHIlI1' 01 Stllllllr,

C"1'<l1 E'crs is CFO :II lwergrce» nnd I~ ,,·.·.l'o'ml1le for coulu.ung these ""t, of deals She vrewv Ihern as if [hey we," 'lock opuo", l'hc dellil" of the plun "frercd hy SlllflUP Me a. foll(lW'.

EvcrSl'c~n would i'Wl',1 \2 million 110W 11\," would hel fI fund the R& [) nCI,,~ny f!'lr the new drug ,,,e. the ne~l til rec yea". If Ihe n&, n were SlICtC"r Iii SI;lfiUP wuuld need on adUlt "1Il II I £2 mill ion for c I uuc n 1 1",11,_ Lvergrccn would Il:ovc tlrr opuon of prov,UIII!\ 11m n II"lIio. Or II could rernunnte m agreernem ,,,Ih Seartllp TI,e chuica] mal WO\lld IH\I ''''Olher IWO y."n und wnulr! either be completely '"CC""[,,I, paruallv ,ucc<,\,ful. Or no' succ,·"IlIl If the Inal~ wcr.· comple,,:I), successlul, SU1IWp would need M ,11111"", for processing "'I" 'I II 110llt 10 produce fI",1 1I\i1(~'" rhc tl"l~ If the Innis were I"" unlly success: III SIII"UI' '''lUlLl ntetl only 12 '1II1hon lor pmce~"n~ cqurpmcm i\ml rf ure triols were ,11', successful. Ihr (irt'~ would not he mnrkctcd. Evergreen wuuh] have the "plio" 01

1" O~lding 1111< S4 million ('" Ihe case 01 """'plo,dy sucecssful mal) or S2 uulhon (when (he 111,,1 wuv purunlly successful), or II would have Il,e cpuon ,0 IC'"11"ule the agrecmcrot Wll11 Startup

In return for i" mvesunenrs, Evergreen would gCI ~Iocl; ownership in SWIIlIp. If the drug were t1"veloped nnd rhe clinical 'rI"l, completely successful. Ihi~ would he quue valuable, allh"uSit there was censulerable uncermrmy aboul how vnluable. Ae Ill" urn. [""rgreell Ihoughl rhcrc was II 10 rWICCIII chance Ihe value "'(111ld he ~~O million. a 20I""'\'(ml hance for $.10 '11IIIHlII." 30 pe.eenl chance for ~2n milhon. and a ·Ill procene chance fur S 10 '11IIhl1l1. 01\ the other hand. ,I rhe clll1lcllllrial~ were (lilly p~rlially successful. there "'<IS a 60 pcrcenl chance for only II $5 mllhon value, a 20 perceat chance for a ~ 10 m1l1l0M value. and • 20 percell! chance for ~20 milium value, I r the eli 11 Icnl Inols were unsuccessful. Ihe value would be zero.

['inull y. based 011 cxpertence with olno, ""111 ur !irm,. ~vergreen Ihml~'" Illal there was ,,"ly J SO pcr~elll chance thai the R&D effort wuuld "r ~lIcce"ful 11'11 reuched the elil1'ClIlll"Ili1 'luge. il a~!~N"cd [I ~n I'"r(clil chance lhal II ",uuld he complclely !lIcc""flll. 20 I,!:rcent chance tli 1'01(11111 'Ilccess. rind 30 !,ercelll ch,,,,cc l,r being IIIl'"C"'Hhlll,

l~ver8n'en ha~ Ihe ol'tlnn of lerm,"I11I1lI' "' .lgrccmcnl w,lh Sianup ,11 any lime. Ho"C"ef. ,f Ih" IS ,1m,.. Evergreen recelVc, ",,[lung frOl" Slarllll'

Di"gram Ihe prohlem Incillg Evergreen. Ignl),C any 'I.uc~ 3>socialcd wilit dl'c!'Iuni ing cash now, 111 11m s,mplified problem. 1'.lller Ihe prob~b'''I'C' III Ihe lrec ~ nrl nel ca~h tlow, al t I,c end of Ihe trce. k,,11 Io~~~ I he

uce and rndtcare wl'OII I':o"'grccn should do 1'.11,"1 " the I' IV"

6-.12. r'ol1lhnll COI1Cc.<lIm, bud the (rund",,· 111 sell ~ofl drink,. hal dog s. nnd '" on "I 1'.10,"11<1' Univcrshy home 1001 hull game. 11m wa, a profitable operur ron. "lice crowds could be ~'''rn,lIcd reasonably nccuflltely a'1(1 1110 I iShl amount 111 f""d 1'" rchascrl.

However. the Novcll1locI' weekend W"fIIl", I WII~ due 10 pilly '" arch rival. Cnrbunklc U .. posed a problem for Int· cnnrnvsrnnn aire !lOlh rcarr« were IInddc.Hcd. nnd

I he WII'"UI was s ure 10 ge I ~ [Iuwl hid. i\<1 V,lIlee SI"C~ 1)( lid."" uuiicated Ihal ,f rhc weather w", mer ,j crrrwd of more than HO.OOO people couhl be e: 'peeled On I he nthel hnnd. " was rnlnlng on h,day. ami Ihe wcurher ple.ulclion called fM 1'(I>,i"l. showers or ram nu SmurullY If rhe m,n WU~ he,lvy. " was pn"JIoI~ 111.11 01 "!lwei of unly 20.00() wo"Iet "lOW up fnr Ihe ~~lIrnc

I'll(' cnllc"s~ionnr""e hilt! In u"ler hIS fond Oil Frulay.

I It- I\cllcl!,lIy ordered nn 111" I""" of $.50 reI pc, sou. ,uul Ihl' hnd proven reuvonubly accurate '" the 1'1,,1 He 1011(1 01 rnnrkup or tOO perccn: (r.c .. selhng fUlL r wns dou hie C~SI). He could 1:,",cfnlly save nbnut 20 perccru of I he value (cost) of .nylh'ng 11101 he had I. fl uvcr

l he concessicnnmre nssrgned the folIo,," I n~

rl 01,,110,11110,\ to the vnrtous rossi ole crowd !lIC' 'He gel1c, ally fell that ci I hl'[ ,I would clear up 111111 II III rgo CI"wd would result, nr I would rain and " "lU,1I crowd be present. The po",h,lny of " medium ·'".ed rrowd, he behcvcd, was less Ii ke I y.

Crowd vu»

Prnbabrlrt:jI

20.000 40.00() ('O.(MJO ~O.OO{l

010 020 010 O.~o

100

How much food ;houl~ Ihe conccssionnarre order'

(,-;\:1. Pncaleffo POIRIO 1"01I11"s (PPP) buy' f rc,h ldaho pOI.1I0e! Hod processes them into frozen f'<IIt'l, I rrcs and ouie: Iro/cn POIIIICl pI<"IIICls I'pp buy~ 11\ 1,1II"lncs in Iwo WHY' hy prt~ea on COntracl and hy pludm,e on ehe opell nlilr~cl. Unde, a prescu,on contracl, ."tered ,ntO Ilof'(I,~ 1110 em)) is plll"lI'rI, Ihe processor (1'1'1') "!\'CC\ w buy lhe crop of a roo,alllll",wel al an agreed r' u:e flcr hundredwe,ghl (ewl ) of 1'00aloc,. For Ihe CUllenl .Ie"son, Ihc pre,enson CO,1lI'nCI pncc is M p~' \;WI. i\ltc"wllvely. PPP cnn wnll UI1I1J Ihe POI"I" emp ita< bC~rI IIAI ~eslcd and buy,,, 1'01,"0 requlrement\ on Ih" rtpen 111 urkel at prcvnilo-lig mnrkel pric" •. I n I he pl.SI few yerl['. markel price, of 1'''''''''"' ; n [daho have 11(1 clUnled

zxo

cnnsnlcrnbly, ,angl ng f rom $7 In 'H per cw: P'<"VI"'" I y. 1'1' I' hns preseason conuac ted for ilhoUI 11111 f '" 11",".1" Iii hng Ihe 01 her h.,11 wilh open mal kel purchave

The r,e~i~~nl llf rpp IS rccnnsuicnng I h" elI"'" I"n

S IlC thinks I lie 1"'"'elL,~on conunrt price lOr til I' IIlI> III ~Il ami rhat Ihe,c .ue atmcst three <iIIlIlCC' "ul "J I",,, lb." III c rna r kct P'1CC w,11 be $4 <JI I.,"" I" facr. ,11C Ill" ,,",dully assessed a probahihty d"" iburion 1'(" p,,,,,hl" open- mar kel rro «., of potatoes

O,U-PI Mm'kt'l Pr,r~ r ~ p,rj cL~11 !

S2 SO ,I no .1.111 HID ~ SO ~ ~f) 110 600 6,50 7()(J

0(12 Ii III 1),111 I) 2(1 0.11 006 004 00.1 002 001

1.00

13ccamc or nllo"r requir"nlol],l, (storage 'I)nce, ele.1. 1'1'1' does ,,," "ilh 10 Il."e I~" lllnn )0 pe,'ccnI "I il<

I eq",remenh PIC!c.~son comrucl.tI. n,,, more Ih,II' 70 p~rcenl. NeXt y~nr, I'PI' will 'lr'l,d 2 1I1111ion "WI nl 1"""loes for proccg~il1g, A'~"""n,\ [11"[ PI'I' w"I1<"' II, Ill' 111 01 I ze I he e, Ileeled coM of ,,0\ ~({I pu rc 11.1,<', ,11 oW 11l1lC~ shOll 1,1 Ih~y 1" ese"'On """"',,;(' W hal d" Y"\I

I CCUII' mend I" Ihe preside,,' III 1'1'1'"

II ,Jq. A chemlc;11 compon) " h'''hh nl: " pl"1II UI IlH] rket Agri )inll, n I!CW chcmH~nl lIsed prtmrmly I ..

8g' ICuhure Tile hI m ,is une.f\H,,, .,bcIl'\ 'he dcm;lml lor Agrlxon, d"'lng Ihe In;[ial yon, of ~.lle., Ho"",""" Ihe

I (lilowing prabHbl1 ily disl riblill orl WH' ""e".ed,

f){."jt'fl rId !nr- A~fr,.l,nrr 1m I." fal r.", rklloR 'II'"! !

ROO 1.000 U(JO I ,~I)O

0,2 O~ 0) 01

10

Agriwn " p .... dueed on a 'l'cC lal· purpose m.leil "'e.

I;ud, such m:.chJllc has " y,cl~ nI 200 k ilogrr" '" "I'

A~" ~M pur ye.,r lhe Il.\c<! cOIl or p",dw'ms ~nd "il~II'IiII~ ',lI,C maclune i, $%1l.00() I'CI' )'~lll', which Inci L~dc ... 'i.llpl:f ~i ~\Un mauucnancc. ,llld utner a",c:(1

,I Ln, 1',0:', plus "''''Il.,I'/,cd rruercst :ond c'l Lli prucnr CO,K SU]1]ln,[' Ille proli: Inuu onc y"a,,'~ 11I'''11i1~I''JI' of oue 111 nclu lie (nru I nclud 111& ,,"cd ~'" I ,) " ~ I ) 11111 hon , ::H;:';~llrHllg dcrnand Iii ~~II'I~Cleni [0 run the machine rUI the enure year.

The problem f;IClI1r the chermcal COlnp"ny rs ro ticc,<i. how many' 11,1(;lil nCI 1(> i n"all In rhe pla III fm I he Ii ,',I YCIl" The second ~ I1d sLlhSOq'''-1L1 yr,llr' rose I uue pwhlem. because rhe hr rn " able 10 hll)' edd"inn.1 mildHnc~ 1 f needed. I •• HI nn y u [lU!HHI t~ •• rnc II y can h(: ah~rll'I,,,'d in. rLlUw' yell:! ~ as sale!': ,S,l'tlW

I (ow ""my machln~' .. hould I he II! 111 Imlall 1<)

mil '< 11111 I,U expected lie! pi Drl tin I he 11!:i!.1 YC4·~r?

(,-,\~, I rutc EleC11 nllie, ("n,"pOlI1Y h", "lIllolCd "0 uruurus .rnd unfnrr 11,,,1,, prucuccs lawsuu "Baln~1 Arlr, Cnm p"le"s, ask inl( '" ,ulll~1 neni (If $10 111111 ion i [1 dal11l'ltC' On NOVl'I1II1L'[ ~, Lillie receives In offe, 1'11"" Arl"~ It> scnle I he '''Ii fo, a r"yment In t.uue of ~J, ~ nullinu

I he manegcmcru ., I. III le is "Y "'~ III d"e;de whether to ~CCCpl the seulerncm roc 10 proceed wrth the suu I he I""y"" agree 11131 1111" cl1[IIICe, are "ho"l IwO in three Ihal t.uue will win I'lley poim OUI. nowever. Ihao even il 1.11I1e- w,,,, Ihe ~LlII, Ille chance' lI,e [Only ObOlll nn. I~ '''0 11'111 II,e judge w,lI ILwMd Ihe I\rli ~ HI Illillion; II,,' IIId~r " cq".llly II kely In gran! " rall,.11 ,ell lernenl nf S~ [n II hOIl Thc I~w yen ILl "hc' e~Ull,"II" II IV ill cO! I ~h""1 .nOD,nOII in leg"1 fl'I'" I,elw""" Nnvr.lllhc, nnd J",,,, (",hell Ihe C;l',. " <;I:hcdulcd In h. hCilroll, plus anlllh.,

~ 1011.000 '" legnl reo! 10 I ry the ";"" (wlneh " "xpe,'lell 10 111'1 'I h I co I1lnnll,s)

I" maiung lhe o[fe, 1011' (he $],5 IIlIllion SClllelllCI\l

,\ nc~ ~"c"ed I hOI" w," ~ .. rLn,1 <II fel." ""d Ihal I h,· ofler would DC go 111 I 1'01 oilly ]11 II flY' liowevcr, I il110 1ll;II1 "I:c me n, an d I" w ye rs ng ree ,hal A n~ x will p rob. bl y make 'I ne" offer In Jun", jusl hef"," Ihe Inal beSlm,

A rici SUllle I hough I, " ,~ dec ided 111>11 0 (,0 is a ~O(ltl

e'l IUl.llC "r Ihe proh,IIllillly (If • new ",'U offe, m June And if (h"'e is" now "lie" InC ch~n«" nrc 7 in II) 111,11 il Will h~ $4,5 mill'flnll"d 3 in I 0 1m ;1 ~5,5 ""II"", 'eulclI1cnl

II A r "" rn;lk~,\ no I"~I mlnlL Ie nll'll ill 111 ne, 1.1 [II" II,," II ,:111 Lllil ial ~ "'"lllemcnl I n II,,~ CI"", I.ililo will h.,"" 10 ,.lIle rn, $2 ~ mill"'n. hec"",c A IIeX WIll 1111\'1 I" ("I h. ~CI io" 11.\ Wc;, k no" ,n I.'III~ \ c~;c.

11 ing, am Iho rlcc I \1"" proble", [lie "'f. Lillie l::lcclron ic!. As", mmg r. "lie 1.< wlllIII~ In use EM V ,n l1l~klllllll1i, deci,,,,", wl1:11 s,,'alegy ,!1oLlld DC u~c,I'.' 6-36. In ~.,Iy Jao"", y, Ella LahOflllO""-' recclved "" nr,lcl f", 10.000 ouoce! of us new prnduel. Calho," ,tc. n n. i I1gu_'~ci ie.nl ~Ised lO mauu facl .... t' II II{'W 'l.'llrici y or

,

~~' I

,1

, ,1

"

!III

II, 1Ii\~ I hi; ""~~ h~ r.or rhe largc~1 {Order ever rccci "cll f(II ('"II,o"ilo-I(l1111 1",,,(111,,,,," I" the previous Y~"' I,;,~ hct" ,,"ly 1,200 nIIlll"" The ,,,,lei c;llled (or HIIHI ounces In he dell _01 cd III June and the remmnuer III N(IV~111IJeI',

fhe procc.;S.'S nuw ..... cd In "iynlhc ~Il r Cnlbonllc WIl ... ,. tong nne, Ifllr,lolvtng processrng !'ml!H batches of raw rnntc rial through """,,'.11 ! tngcs T 110: cnrupany wnlll,1 hove 10 ",_.51 S'iO.OOI.l In new equrprncn] I" bri ng I he pruductron capacity up I" Ihe 1.000 0.1 nee, per month level needed 10 111"",1 1"0 order. (IL w~lIld take rhe 111(1,,1" of January In ,,((kr ,,"d "" up the ecurpmcnr.j T 11" vannblc manu rlH:::lLn j li~ lnS! per nu nee ~J"'Ulg rh I" 1""0"" W"' known (n I,,, $1.\

(lI", <I( rhe research chef,.,;'" ", 'I' UJ had JUSI drscnvered a new P"H."~" for ~y no 1i"'11i ng Calbunne If II," process could he IIIIIdc 10 wor k ou II lurge scul u, 1\ M,uld l!\really ';mpllf) the P'(l<lll~IIII" process, wuh pntcunully gre;" ~n"",r.\ In CO,1. ()"III1.Lr1ly, a dl~en"cry 01 IIII~ sor wOHld be IC'I~d llio"'''~',lil ~ ill the Illl",""l!>l'Y ami In ~ small pilol pl;o,,' 10 be vurc II worked "",I I" esumare producunu t'Cll.j!\, Thrs W('HII{I uike about IL YC411 However, bccnus "I' IIIC potential Illv"'g'_ rnnnngemcm ""lIlde red if II ,h,," III ,hnrle R I h" Ie" ]I<: "ud, The

engl necri ng depart 11l~'lI suggested u C'I 11\11 test i ng progmm lasung rL ve moruhs. AI Ill" rlul of I h ,., pc"",I, ,I ""'" Id be known whel her or nnl 'he l"I>cc« .... '0111<1

Will k, "ndes(i mmeil I",oduel ion em I~ w~"ld h~ Iiolcrmllled. ThIS "-'I would COSI \20.1100 Ino,e 1110111 111~ In o,e 0" len ded !t."

Ii "'"' ""il1"'I"" 111111 Ihere WII' ;1 (I,,) clll111ce I". n~IV rrnc(."!oi.~ wcmh:l \~Ol ~l f~urlher~ ai VI'n I hrH lbe new prm.'t:."i.\ wo, ked. the chnn,'r, wo,e ~ <)111 of 111 Ih.1t I h~

I'lL" IUCI ion co,1 WilLi ILl h~ $2 por ",,",'e, 'I 0111 01 I (I liI.11 il "'''" Id I,e $1 (I pL" L IUtlC •• and 2 11111 of 10 Ihlli LI ,"""Id be ~ I ~ pcr ""nco

~ r 'i decisioll wow, mndc ,H llw.; f,!ilgC 10 use! he. !lew pr<JCcI', the mnnlh 01 June wuuld he u'ed lo,el "l' IJL~ ncw ,nanuf"cillro"g p,ocess. Thul. I f I h" lesHng pragIUm "efe Iii ill "cd, I he COlli pI' ny WOu 1<:1 have 10 SCI up.nd run lhc fi '" ~,()()(l ounce' "" ng Ih. old p<occ"

AI,Q, nOie Ihm Mly [he, ner<lI'lomai ~osl~ a.~oCIi"ed wll h "ush lell i ng [he prngrarn w<=r] I" be cha'ged /11:"111'1 Ih8l aller"",lll'c Since 'h" ~"lI1pnny "'Oll III I"~I ""d '*y the oq'''pmo)ll for Ihe n~w procc« If Ille I'"'' wen' 'lIccc.,sf"I IIIII"I",,,de"l nf 11m ,Ic<;"ioll. IIIC ""III "",)C ,"'led '"" h I he w .Iel i VI ue~ nced ""l he co", IdcrcoJ i!1 1111, dee'I,on

II Draw n dec",,,,, II~O for Ihi~ ]11'<1111'·"L.

b, Wlml dec",o,,, .. huuJd be miltle" W ,,," I~ I Ile

e~pcc,ed cml 01 ~III ng lh" ",<I",'

6 .37. Mary Llllnil i, Hying IQ decide wllal 10 do lib"" I on up"rlmcn! buildIng ~be inhe,IIc<! (,om her grcal "Un! in Walla W"lln. If ,l1e wcre In .Iell II l'lrIELY, she cp"ld gCI

1.IOO.OIlO Since Molt) rlnevn't need I he money ,ml11odl"i<'ly, she ,; ''''I~''I~rll'r. 1101dln~ nn In 111C property I ~I snle I "'I",

S"I'P"'" M.or) cnn vell lh~ build,"~ no", ,n I he end of" nC~1 Y(\I'" (yell I I), 0' DI I he end 01' 1110 foilowl ng yell! (y~a,' .) She I"" ,10",,1, rl nOI 10 keep II "'''' C lh~ n I "(I years

I 'or cnch year II,", Mury k ee ps rhe bl"ld,ng, she receives $~.I)OO in rents (aclII.lly, rem I~~~ "I'eratlng

eo, lSI M."y consu 11< w " h the local Wall" Walla real estate lIu"" nod rhen .,~~e!,c~ the foll~w'''n probabihues about 1I1.r.It .. a~es or dccrea_"c~ I n [he V.1 ItH' 01 I he

properly [Ju"ng each yo;" (year I nnd year 2) Ihe,.., " a 20 ]lCI cern chance Ih:IIII", value of the n1lildi1"lg Will increase by S I 0.01)(] lind an RO percent c 11III1rc I hal I he Vlllue WIll decrease III ~ 10,000 (Ihmg, ., '" " I ;'1 tie unsculcd 1,1 Wall~ W"II n), T I""c nrc II,.. "","",1/ prohabIIIIIO., for ~(jch Y"'"

However. wh[ll 11;11'1'"'" In I h. fi'~1 yen, and ihe second III'~ ,1111 indepemlcut M 0 ry believes I hut i r I he value mcrcuscs ;0 rhe Ii"l yei", (hen Ihel(' " " 60 pcrccn I chnuce I hal the va lue WLII "I,,, ,,,,,,",,," in [he second Y""' 0 r cou ,·'e. ,I' I he ""I"" dec ICQ'~' i ~ rhe fir<l y~:", I "ere arc cOrl'e'rnndlng changes 10 the second ycur probabrhuex, subject to lhe Mel aliI' prnb!1bllJ l ic:s mcnt 1.}11~d r .. hove.

A~ ~I r.r"'l·t:ul ana.ly ........ Mllry der-Ide .... 10 cunslder unly Ihe n nl!l1l rol recel"od f '"m ~ell i ng Ih" 111111111 "I: (; nelll'l on~ Ihe ,mOle;,,", or dcere";« in ""Iuc, If ''''y) pi", Ihe

a 01011 '" I c~e I ved [or rc m (I)" not "Orr y "bou (

{I i 5.COl1110ng Or [ilXC~ III o! lief cornphcnUflll:-. J

" Dlnr!rlll11 Ihe decl'''''' 111'nl>l"m faei,,!! MillY. T'lCI~,lIc payoff WI'''C' "' Ib~ cn,l, of the IToe lind I""ballil" y vnl\u" wllme aprroprurlr

I}, Wlldl ucci!ion ,hlll1ld M;I1Y "wk~"

c, (Op""onl) A""lllc .1 d"CI>un' '"'e uf 15 paccm Wilill ,I"~",on slllllll,1 Mill y moke'.' (Willi" discmlnl raL. "I 15 perce",. c~j;h IID"S eccc, "L!d ,I [hc en!1 01 yea, I ale wonh ./. " 0,&7 pre,.", value doll"r! e31h now" ,ecci"eci "I 111<: ond (lr y~I" 2 u re ,,",onh

o 76 p,csen [. ";lluc unll.",,)

6-38, Arle~ ('omr"'C'1 " smng 10 pur<:hl"c 10.000

"n i I, of II c"l"i"i n po, I llilll 1\ In OC "",0" Ihl"'1 ,,11 0 Ihe Afle~ product', Tile nld" 1110 be pl"e,'d ""h Ihe I'owc~[ IlI!l'I~I, wilh lilc IO,non "nil< ", he dellvcred ,il " ,8.lc of I ,UlIl) pcr 111<111111 ov'" Ihe """ I (I 111<""11,,

Tile i-r;1!,k Machll1c %np (FMS)" rl>11,,,lcnng bid'IL"~ 0" Ih" mdcr 'f\vn f"';I"" a,c )1"tt IlIlg M r, F""1" 111 I Ii > ;,11.,11 PlS "1 fl. II hid pncL:' T 110 II [,~I f"cl'lI' deals "'Ill F ).)S·s chancc, "I winnll1~ lilt Iud Me h,'111 fi no Ily docide, U) cOII,,(le, only \ wo ~ltl~ ,'11 her $12 pcr ""il m $]) pe, ,," II flo osl imalC' II"" II ,e cha,,",',~ arc lwo [hmt< of wmni"g 81 (k formel P"cc and "ne Ih;rd of "'"'n I ng al Ihe lourr price,

211 ..

l'he \ccood factor In 'nl wll III Ihe dec.sron " the FMS llilil rrl~IILLf"CIil,.il1g ~1I'1. ll'.'Hl'mdllCI;Oll 1'1'O(;"~,,,, urr "vi< ilnill~ The fir>!. I'mn'" ,\, IS k now n In co>! 1. III [lC1 un,1 rhe second, procevs 11 rv nne Ihal F MS h"' nut used before The clue] "11"" "1\'" says Ih", !h~,,' " ~ \II'~ r'llIn h chance Ibnl I lie pc, lin i I cos I "",II 1>" ~'), " one hu II chance ,l1al the CO'I will he $10: unrl :I I,m'

fnll, III c nance !h31 rhe C<'~I ""II I\[" S I I • f P""cc" 1\ I

"""I

'1 lie chief supcrv ISOI 11f" '" ~g~,I"d 111"1 she "1\11<1",, I

an c ~rc'I'i men I WLln I he ne w 11' (l(:e" (llJ. She (:",rld prnduce 10 IIr 15 unus .. lnll I rom I lu- experience 1l,lIne<i. she hell"'.' 'he couhlustunmc un U cost "preuy well

T II c ('.,,1 01 I hrs res: wo,,111 he $500, When "skell I" he 11\'" ,. II"'C I fie ahout how nccunue Ille esu mrue "f enSI would he, Ihe ctnef supcrvisn provided me Inblc hel""

M, I:rpnk " nOI M"" Ill,,, ,II"," rormnl;on " III 1111 ",I "",,"1 IU I", problem, I Ilr. "onll'~III'" ""S nrgucd 11,," rhe 1<''1 '"gges\ecl mRy he v~I\I"hlc l,ul SI10,,1(1 Iw

p" I 1<" rued after the bid 1$ """uded Odler "'"'0. he '''!1Ut" Ihe firm may spend ~~f)n olld then nOI wm rhr "0111(';,,1, The supervisor II~ I rrve' Ihe res: should he done belore the bid. smee il 11l0Y i nfluerice F MS'< 1",1 pflC~

wh,u ~CUOILS should F M S I.,ko' Whal " the ~'I'"I'I"iJ profu?

l 'h nnces Or Vo rinll~ EIllm3 led ellsl,~

~\lr/wr\u(.lt ',I
J. ~I Irjurrl"a CrJ11 ~~ ~IO ~II
\ 'I OR 01 01
10 III O~ 01
II (II 01 o,~
III 1.0 10 6-39. The Flrcez y B rcak 1'",1 I 'cods Com pa ny " consnlcnng rnarkeung a new i1r."kfa51 cereal I fill<' "" W cCf~"1 " succe«ful. " Will mc"" a S I 0 011111<>" I'TOf" (prc~er11 value) nVtl Ihe life or Iht prmlurl I J ,,,,,,,cce,s[,, I. " S2 mill i<l" 1m, "" III"esl menl W III be

,nc "",co. Mnnagemenl C'''' ~UI J ¥ II II II~' 111cfe is " SO .~O ch,once Ih"1 .he prodnci ,",111" 'ut~e"rul

1'1'1<1 ("(Irkel rcs"~rcll 1"1111 I","c JPpf'Qachcd 1\0'"(', Y WII h r .... upO.l,j,n I S LO oh~ n i I~ 11101 U 1 lIfo,. IrlH\ i'lln, Allil ~Itlt~

S" '"CY' "olleCI' dOl" n" """,,"nel' "" il "d~, wi 111 II"I"'CI In, 1"'('1 he eh" rae ",n sue' 01 a I,wd UCI. ~ lie h ;"

sw,~~~t rH':"'is. ~~Ioric conu::nt. rHIl rH I'Ve \o'tdue, 4J nil "'0 ml, ~1I!111I'ndll"c,. for"C~SI DI '\II'TC.\~" or "f",I," Of 11,(' 'iO ~1\,Mic, Ihis cornpan~ 11", p",lol merl on ,i"11IAI' pwdn<l< rcccmly. Ihelr .'pcflcncc II"~ heell ~, roll",. <

A u i I urle .... 11 r vl'y~I';x pcrtencc

-:::-1

Ojlie-fUjl,. ~

~l

._1

'II

A scmn( I ('I "'ll'aIIY, MaT kOI Cum 1><'1111' III Inc .• perform ,(M.d)',,, In "" enurcly <hUel"n!, moependcru manner -I" h~1;, cnlnp:..ny performs c';'!~n\t\Jr. analysis on, cornpcru I ve II r oduc~s, auri prorl uCC'1'I ,1 I eC(H11 n lend ELL ion nf "success" or '11";111" hased on t 11(.'. nunc i pared amount and qunluy "I cnmpeuuve prnciuCI' II, cxpcncece wuh 50 Sludle, h." ncen n ro!low,

~l>l!'kc I C!H I, ]1('111111" Ex perience

Au nude SIIr .qe' dll"~cs S I 00.000 per ",n cy, and Markel C'LlI"pr'''Will charge, S 1.1(J,1~1O

Q, C:~l1s"I"I' Ililly IIllimcie Survey« IJ~" Illb,,~illn rrec 10 1]0(,,11" whether or nOI Il re~1 y ,I" 1111.) purchase

It u ~ c,,1JI 'I,."t.~}

11 Cnnsuler ""ly MI" k"1 Comperu rnn, lnc VIC d dccistnu I ""," I" rll',ciue Wh"Lh~1 or 0"1 Breezy sh~ul,1 pu I'ch"~el h" "" "c~.

6-40. 'fhe \IJlA Mo,ie Studio I< Irym~~ In decide how W dl strihu re I ~~ 11CW movie C"j\y.~, TfH· rno'Ylt h3~ [he porenrint or heing n grcut financial success (a "smash"). bUI the excc"n VC~ ;11" nOI su re because the s ubjcct is ~on[fo''Cf~",1 Aml!hey have seen some 111111< heralded a~ '·"S.lnn'li.hL·~' 11~(:iHne "flops" wl·~h d!"iII"'lruus ~IF'I;lnc.jal r.::~lnscq~ll,.;llcC"

The d",'i,11111 f"dl\g MBA """11,,, h", 111 ""I 10 P" I nlll Ih< """"~ naw, on " JlIllllell 1"" ,I III" h.,j, Thi~ m"ons th,'1 Ihe n")VI,, woJl sho" ,,"ly In 11 few $clCCI II,cillcr.' tlmin~, 111('. iii SI ,IX mOI1II'I;, A fl~r si~ monlhs. II wili PC rd ~11"'rJ 11""(:1'[111 y, If Illc J11(wie Ii" ~~ Dlil 10 he " \ucee" !h" I. clem I.y Ihc he" "ppr'Mch Ilccpuse Ihe 5wd 10 mH k," ""m Idcr abl e profi I r rom I II,· '" ,elec! tllcatcrs,

Tile nlhe, Irll.,'I1VI'"" is 10 role."" li,t· Iii,,, 1'01' wide <.J"lritl1d1 Ion II1lfned I aIel}'.

tll.l

I he' prolits for the I w., ahernnuves are grven III the i"'C" II 'I lElI1yLng table, 1",,1 d,1S!IIICd tn terms 01 wll~1 her rhe IIIIII'~ n "Smash." "Merhum" !UCCe~~.1l1 "1;1,,1'."

I'wllc, from Film Claw:

I\rl.fJlj.\

1.,.1"'.(1/ Su,.r'~U

t. mil Icd It:lil ia I R~/~~Sf!

W.,Jr fiJI r·atl Ht"It"j"t

Sllljl~l, Medium HOI'

OJ 0'1 OJ

1,0

~ II rmllion ~

\2.2 mrlhon a

10

There I~ c!>",,"crllhle ,j"cD~,ion In ~Hl/\ IIh"'" Ihe POICIII wi or c/"",,' M,"'''gcIIICrH has fl n oily "!II "",I un

II LC 1'",1"'011 i Lie.' show 11 ill 111C IILbk. but wluch d"c""", 10 IIInk" " "iJ I nOI clcru One puss I bil i Iy " In have ,( lc w 'lie a k prcv ie w ·' of I he ",''v It· ami go I the "lid I ene,·"

Opl n ions, The cost of o;;lLil.:t1 iL process WQ\J Itt h(.' uhnll! $.10,000. /I nd severn] ~~"OL" I vC.I in the canll'""~ ihurk u WOLlljJ be money wasrcd, !oi.1 nee sneak preview jim] 1(_~I'l'C~

te nd to rure ~i IIIUV re as good or 011 I IIii umch ng eve J1 wh r:n II 1~I"r rurus ",II 10 be a n"p To "'I'f'MI 111". Ihe followllll~ 1[1111" wn.' produced. dcsc rli1U1g I he company', pas I experlc II~" wi 111 40 Ineak prcvrew 1",dl~"C~ ecacuons

Sneak Preview Audi.cllcc Renctlon

A!u/ji"m,.
RrHrrl~ Sm,ldl M~drujr, r'~jfJ Tm~rI,\
-----
OU~~.nl.~~ll1r. ? 11 l~
Gnnd I (, 12
Pnnl 0 2
lblnl, Ir) 20 10 ,'11 a Draw IlL" de,'"",,, Ir~C fm Ill" problem

b. CILI~"I,,'~ II", 1l\l'I~rior prnhlLbilill~R r,,, "S,,,usl\,"

.. Mt.:'U.i.~IIII," a IH.I H Flop." gL vrn ~ IH' VllfL{"H.J!\ audience rcacuons

c, Assume 111.11 MBA I' willi«t I" I""c no dCClSI.OIl on expeoled 1l1l"'~1 ;LrY value. W h"l rtcc rsion shoul d the M BA Mwvl~ SI udio make n bou I I he rnovi e Cia WI'

1VIi\II.MlI.ltT

M Hi 1"'''rI " " gr"wI II~ ",,,,I order C;LI"IOIl COIl'P"IIY spcciali ling in "I(,y' 1'", V.roWfl- up girl, IIlld hoys." II feal III c s n spec 1IIIIy I lne of curpeuu Y "nd garden Lrlg 101,1,. !;""IC' and p"!.ll~·', MId craft supplies such "' needlework. Mailmorl produces and mo,I'" cal.ll0l: quarterly In" select rnaili oS I i." made III' "',,," Iy of paS! ~USIOI"e,"

In order 10 cxpnnd, MUII","" occasionally runts ,I mmJing lisl from nn oursrde source ~"ch n, nnother cal.loA C(Hnl'iH1Y. ~ credit card cornpnny, Or a magazine. M"illll~rl has j ust been oltered "ne 0PP0rlUfIIly 10 rem • special mDlling h~! from Carleton. lire. " company I'llal 'pcclohzc.' In CrCAl1ng 1n.1lhng I;SIS. Cnrlclon d~lm' Ih," Ih(s IISI h'" bc~n specially e"'~il .. l fOI M,,,ll11~fI and coml" '" only Intli vidu"l~ who h,,"c Ille righl otl~ll"ne, prolil" (mode",I!: it) hlgl1 illC(,,~e, older, hOll1(1 "wnCI s. pasl calnlog hllY"' '). Tile li.ll, 1I0W"V"", is oxpensive, SI''' cili,"lIy. C"rlcum ;, ;11'1"'1' \ 100.000 far I hc' 1m of 100.000 nan Ie!,

'l'nny" MeDon"I,1 " I he pre"dem of M,"ln"" I .lIId <he I~ "neer!n", (Iboli! ,,'IIClher nr "", 10 fenl Ihe IISI III ILIldillLin 1(1 Ihe S 11)0.000 e,,,1 of the I i~" ,I ",,,,,1,1 co" Mad mart "'" 011'~1 $150.00010 ]1llnl "lid IIwil cHluIOIl" So Illc COII'P:'"Y would I"L"" I" "IYe,,1 $25ilJK1U hdOl ~ ""Y sales rc."JlI~d And MeDon"I,J WII~ quile uncennin "how 1 iI~ !"k.' Iha I wOllld 't,IIII To help make dcc".nn' ~ucb a, !h~,,'!. Mailmur! focu~; on Ihe ~,e •• gc dolla ...... ["'''' Ihe ClJSlOmcr'l Ii "I ("'lcr, U~u"lIy, Ihe ~vcrngc f"'l-order IlInUUm W"s only abO"' 11 1'"" ""me on Ihc mallll'I'. 1,,'1 (nUl" Ih"l 90 poret',1I1 or mOre mighl areler nothing). ami Me, Donald Judged ,hal Ih'" IVa' J ,71) probablilly <If 11m. Howev~r .. llle j"dg~d lilal ,her~ w,~1

,0111<' (:1,1111(:" 111'01 the Ii>! fmlll ('111'11,11"1 rt'.III'Y was " srccinl h~1 111111 w(",ld fC"'" III 1\Y~,lag(' fll 'I'milel .''',~~ of $11 per ,,,' 11;1",,' (w1l11 IllnllahilllY .201 nr ~7 1'["1' '''1 11~J11" (wuh 1""'"'' h"lIy UI)

Il."rti (I" 1"" I cxperrcncc. Muil 1l1I1I1 "'("''''10,1 that fer e,«!. $1 or ''''1 order, 'he C()"l1',"'r ""111(' II 111.1~"III1ICd pror" (JI $I,.!II 1'1", I"k~, mro uccoum 1110 ''''.1 11"'1 a ~U,In"'CI' wlllJ orde 1'1'1 (Pille hi.lt= a good dHLIH!l.~ of lllllt,:.l'Ing ilgH in In [he Ilu lin' n IH.I hccnrrilng :1 fc,)!ubll' CU~IOIlW1

rnklll~ (1m 11)(0 accousu , \1c1)t>ro.,ld h." summarrzed the p,~orf' If ,h~ rents II,e I "I II' (he fnlln~~lt'n tahle ,

l~jUOU'I'i'l1 It .... ,11

r ~ r/t(1 jl\tHl -ts ~

A\I~l'lLW' 11I'dt'l 1 ... ';1 l\'r,IIC:I.IJ.l,1!: nld~l I~ 10d ."" v tfl1~~ tjl~1cr l' ~ 1

lllll ~, )(1 ,I'm

[1") III 01

'I Alrls .. n'lllg !hj']1 she I ... :111 I,;lj,Pt~~·II.i(1 v •• luc decrsinu IIIJ1kt.'I, "",IHII dl,;Cl:O:HJIl !=hould M, I )"",,1,1 make. and ... 11.11 " I he evpecicd value'

I, W h.,1 " the ex reeled value nl perlec: ,0[o.m.II",,"

l1elol e maki og a nccisrcn nhout the Carlcmn mall I IIg 11'1. ,\IIci)oo"'d has" n "I,·", She C1' II cd CM leion and Mkcd , I I hey I'm" lei conaidcr gl" i l1g her a ra ndom <111111'1,', rof. 'Hy. ';00 names f,""III". "" II"d Mailman w(Hlld [II,· Ih~,,' '" a ies: sample rO! the enure II<!. Carteeon Iholll!ht Ih" W"' a good Idell hIli m,,"ed Iha, Ihey charge 1m Ihe sample I"" A "'""'II'g IV"' scheduled 10 ne~"I'.IIr. !1o" charge.

In prepnrarion for Illi, urccung, McDon"'d rhd ~"III" calculmions based (\n 1'"11 c~l'c"~,,cc with I he VI! Ii nhilllY "' nrtlcr [lmo,II1I.' nud ",''''''i''~ " SO"' pic, i rc n I' ~1l11 I1IO",r." fha! is, she c;,!e"h"c<! Ihe ;J1I1"UOI of '''mpl i n~ ~n()( 111;11 migh I he c~l'c, led III cnch of Ihe, C3~t:'~ nrennnnerl ;1hnvc:. These colculLIII.m~ IC~UIIt..J In rhe ccudiuonal p",lmh,hll",-pmhahllnle, of v.mous sample "" ""tile,, 1','""" the true pmcllIl nl nr Ill" I"o.il"'g I is,-slmw" in "'"hlc 6-20

" I how I he decision , rcc for II", extended problem I 'ill in I he probabi) i lie, on rhe rrce and Ihcpayoff' "' rhccnd (11 (he tree. Fnr purpo-c 01 11m analysis. '1:"01(' ."'1'

TAIILI' 6-20 ('nllditinmll Prnhn hili tics 1''I'lIhlll)il i I)' (S" rvcy h""IIIIW I Till. r,HOIIII.,I)

.'IIilt'. t.ll.Walt"· {ll.'t'Iast>i/"IIt1, mll(Jrm' ,..r /rrH mffer jII ~;JjIt"Jt"

true :POl.flllL11 (Ir 'h.ruirt' MuUlnc. Lisl
,\'~"'rnl:t'
~~I
l,tI It \(j/{' ~I pjj,fl,\'I1I,- I" Fp',tISlrl" ~7 "
i'
rl9] (lIO nor, ~
II OR II ~II n If I
u !I III 0, I~
1 (~, IOfI I UO I."" 1111111 ~'! 1111'0' IMine

th::llfIICI"U '$:2' ~n .1111,1 ~~ ~O pL!r IlrlHlt:

MOl'" , ,,,''' ~h \ III I'cr f'1Ian1t:

:lj'

~"'I~ f'" lJ,inH 111<', snmp!e of rr"l"I1e~ supplrcrl hy Cruletou. Wlla, (lcol.,i'''1 ,1"",ld he. uunle?

n. WII"I" rhe 10"'''11''10 .",,,,unllhal ,1.1311 mar I ",,)1,«1 he wilhng ro pa~ C.II 1.'1,,,, fo, (he le~' h~. of n.IllICOIj,1

c,\SF: 6-42 W"UASH SKI AIlE;!'

SUS'III Parks, ctuef analyst fur ihc ,1,lIe Dcpar uncru or l-o.csts. is fcrmulaung n I ccornmend .. uon 10 the governor about Ihe proposed W.ba,/1 Sk, II leo. The department 11,,1 11,,1 BI,,"II) pnjpnsed a run-seale 'k, resort. h,,! due '0 g",Dlone ,hprlilgc,. mflauon. nnd nther fo(!O", the "rlgll'"I e;tim"[e~ ,,1"1111 II," number of people """g (II<' resort have been questioned Two "111"r nIICfn"[lvc~ hay" JlI.'.o hccu proposed. Onn al""'IIillVC i., 10 build " ~IHllllcI' fHcllny ~n" expnud 01 1 n 1"'0 ye"" If, Ir,Ill" nd jusli fics i I '1"100 01 hr.I "'I~rm" i ve is 10 po" pone I he wlmlc 1"")"<:1 (0< I II" yCM \ r,,, k' hil' collected c'( ""me, of en".'_ revenves .• rnd pro""hdi ClC"i r.nucc, rung ~hc VLHIOU~ illlcrrliU IVCS

II will cost $15 rrulliun In build a full·,iw<.l r"clilly .11,11 uno lime, If D smullor IIlClllly,~ I,uill '" Id later expanded. II wl II c(O~ I $12 millicn (0 IlIIol!1 I he smaller in i lin I pur I "lid $6 II\.iIIIOl1 (0 oxpand " lnier 1'", k' I"" do:<:,ded 10 use I hrcc lovel., of pOlenl ial demno"j for Ik""S ,II Wabn~h' high. rneduun a",' low The cOSI~ nod revenues tor these cases nre shown ,n Table 6-~ I, The Department nf ['orc.'(' uses a mens ure of benetus , n evaluat 109 ihrs (ype "r pfOjCCI. Tile benef Is rnensu: c, , nc ludes revenues nnd "<1~I' rn dollars. bUI ;'1 also I nc I Lldc~ " W"IJC for the ,ecr<""li~o benerus providco by (he f"",I'ly (al a rare nf $1 per vlsiior fillY).

II f'ler consulting with he, CtI] leagues. Park.< e~III""le<lhal there is a 0 I [) !"I"",C' Iho< dCmQlld on the ne.<' '''''' Y"'" w,lI IN: high. 0.60 (a, rnerhurn demand. and 0 '0 f", 1o,," uernand: Demand beyond I 11. ,~corld year derend~ on Whlll occurs du" ng rhe n"l """ y~"r~ T hese l,r"hobil;1 ies 11""0 nl,1) been assessed a ",, are ,1101WII ill Tnble 6-22.

Cf",ml~r " IS·yenr pur rurl rnr cvaluaring Ihls POOJCCI. "lid culcularc the WI "I I~· Y"'I' IIcl ''''ncnl, 1)0 nOl rnclude "'lY ILII""""LCC for inflauon, dl;WII"(;ng. cor growll. II' <1"11"" III ether II"," wh.,1 'S md,calcd In II",,,· I,Ihlc, Assume IlInl HI the end of two year s. (he I)c I'Mmlcnl or 1'0'.'" will he nille 111 ,w"I,,"'r dcrna nd over 1M. 'Ilh'CIIIICIII 13 yea" 11'111> ccruuu I~

1',,(11.1'> 6-21 Annua.l Revenue
I~~ u mu res of AI1'Pllml /f"om t.eoses
VI~ltor Days and V •• uar alld rjIrtJ Not
C'nMS for \'''abash I/"y' COllcesslO1U CUll'!' He\"'If"llt
t\ ruu fl!(Jl)" f fO(J()' I 1$000", (loor!!)
-~--
],MW'!'ilt:lLlr:rm;.ilil),
IllAh den ju nd KIIII 52.40() nou 51.100
M C'rI'IJlfl de mill nd l!lll U.oo 7!l0 Q()U
l,(IW dl.:.rrlolnd lllO 600 11'0 100
S,n"II"1 00;,1" fncilllY
I !lXI. ~lC:Hln nd llXl $1.(,00 MOn $1,2{m
Mt'.c~ICJ III demand 40(1 1.000 ~OO 6011
I nw d-cmanf1 ll~l 600 1()O 200 Wrli~hr{'~J N" lI'n~fi'" 11/)('/hJ

\/ .•. IOIJ I.JOI) 1110

I,I,WI!

I,UOD 100

TABLE 6-22 Prohnbilities for· Demand at WabAsil Facility beyond Year 2

C,\SE 6-43 PAFtTICULI\!l MOTOHS

r.kjtWII~i DC1t.trrtd
U1J 10 /j(},\'Ollri
Vt'OI' ~ y~11I1' 1 PI obnlJI'rt I'
----_.
HiSh HiSll I.D
High '/,
Mcdiu III Medium I/~
Low ./,
High II",
Lnw Medium '/.
Lirw 'I· 1~'ilHdJYI a.~$LlnH~ ihnt Ih~ cil:P111"1 men I 1.1i. \/VitIi11g t'l U~L: expected nr.1 hcncf] •. 1,j, n.'; 4'1 CI'jlcrinr1 LJI IIHLf\ i ng II:::: rccommendnt jOI~ In ! be. gOW:I'IHH'.

(j. D iilg_f;IIYI I hl:'\ dec i sion prohlcm OIS a (It~Clsion • n~t,:. h. Fi II i 1'1 the prnbii hi I~! i cs :-ll,d L1C.11C Pi l~ ill I he tree.

c, Vo.'ha~ rc CQ 1'''1 rnendarion shou ld he made. I o the: gO\o'C.I'1l01·?

In J une 19L)8. I he rna l1~gi rLg {I irccror of Pml ;c"I'1 r MOIO,..-, an A lI,1 ,.,\ I ian nutornobilc rna nufILCWL'CL". i" considcring 1I1C f"lUre or the Tornna L11n(ICI Currcmly, the Torana i,l offered with " chorcc of un L~ Crll\;110 (Inur cyli .. dur il1"1rmle<1 rmOlL Gcrmuny). or ILn 1.0 or V8 cnguie, boill munufacrurerl in Australia. A III aj 01' rncc-lifl or IIIIS model is scheduled [01' 1'C.IC1lSC In 1 he pllhlic in Febru nr y 200 I, A rnnjnr dec i;:';'1 011 Irl vnl vCS W~ICI bel' \ lr Ilul l'EJr ucular Mnrors "hOLLId bu i Id its own L4 engine in AU'I ral ia.

Australia , as elsewhere. is [aced with an energy cnsis Untie!" serious consideration by rhc govern III em in CH nberra is. fI In W '11::1 ndar i ng .n _~lIL').st[j ru ial increase in [he price of gasoline, SU~ 11 un inc rcase in gasol tile cost wou Id lead 10 greater sales. of the Tora na wi: h [he smaller fA c.:.ngi ne. ~J nd reduct ions in s'.i:l1 es of ! he Tor-ana with l he L6 and VS engines. Three possible price, for gasoline may be set by rhe govemmenr=-St I O. ~ 1 . .15. or S l.tiO Australian dolla,s per liter. The sales department estimates sale, of the three models over the three-year period 2001-'1 as follow, (alter 2004. [11Ere will he a new face-lifl for '11e T""Ln,,);

'l"nUl·1 '1'II,n'::CuVcnl". ... t Srll ... ~;'o; elf Turuuu wltn .r
G~uOltllt'
Price 1...4 EllgrrJt' t.o etlgillt' \18 t:.'II,~irUI "ow'
$1.10 25.000 75.000 CO.O(lO 120.000
IlS 80.000 7.1.000 15.(JOa I JO.OOO
1.60 120.000 ;0.000 In,non I BO.OOII The corunhurlon I'm each lyre of em i.,;

Pmfrl ['rJ,jrl'rbJrlwll per' C(JI'

Tornnu with unportctl 1.4 eng! nc ~ 100

TO[ an a .... -uh Austr alia 11 L.1 eng! 1lC" Joo

Ibrana wuh 1~6 15{]

Tbranu with V:;;: 400

The public rclauons expel'! in Canberra is asked ahOLLI the outlonk for fuel prices. Aflcr scnous coruidcraj ion, I he following proliabil i IIC,I n rc ,,,~"-,,,"cI:

,
r
'I
,. ~
" r;
',. ~':
, Grj.fjfj/rrlf!' Prrcr {$ iJl1r' lift'I'}

$1.10 Uj 160

(I. I 0 0.50 o ~O

100

fI "om pi icm ing fnelllr Ln IlL" decis ion about lou i IdilLg I he L4 engi ne inA LL stru I i ais 111e pn"ibll;ly of passage by rhe govcrurneru or a Local Conreru Bill. This bill. if passer}, would force Toyota and N issan to increase II LC loca I conicn I of I hei L AII.'I rn I inl1·,'~'cm hlcdca rs, "nd rhis man, buying an Austrnlian model 1.'1 cngrnc, There is a GO percent chance this bill will puss. and !'"niculir MOlOf~ would then ncgoriare J COnlf;1CI with Nissan "nd Toyora (nssurn- 1 ng. of ">LL esc. I hru i L had decided In prod Lice I he L~ cng; ne in AlISII'" I ia l 10 gel I he J apanese busi ness of 100.000 L4 engine, over the 2001-4 period. The corn ri D1Jl ion or eac 11 engine solo 10 the J IL r""cse is ex 1'~ClC(1 LO be $100.

In order 10 set up the manufacture of the Australian L~ engine. Particular Mowr' mLL$I com mi t $4 m;11 ion in 1998 (before the fuel price Or the Local Contenr Bill dccis ion is known I 10 build the main transfer line for 'he engine block The completion of the production laciliry will require an additicnul S 14 million, bUI Ihi, cun be postponed uruil alter the governmenl decides nbout ihe fuel price ,'"U on whether Or nOI 10 pass rhe Loc,,1 Comcnt Bi]1.

To meet 'I he rcqu i rcmcrus for I be Ja pa ncse con I r1ICLS, add i tional i rives I men [ \Vi!! be required This can IJe done in one 01' IWO way •. A $1 million investment now will incorporate the necessary rcqmrernerus iruo the producuun system. anrl an addrucnnl $1 million will be required when rhc procucucn ,y>lCLlL i.< completed later. Ahcmarivcly. the production 'yOiNIL can 11C m(ldir,c~ 1,'lcr (af'rcr ICi"nil'g /.1)0111 Icc I pnccs and the LDC"I Content Oill I. hLIl In <I" II 'LL thai Ii me would req II ire $~ mil I ion. I Note. I n II", probl em. all Sun i rs nrc A ,,,I rul.nn dollars.]

a. Draw up the decision LI'~(: fllcing PClI'1 icular Moror s.

b. Inchtde only [he incremento! rash flows associated with rhc 1..4 engine dccisjon. r. Inc IUfJe the probabilii ies on the uee.

21111

rI 1'11111111<' oplima' ",<l'ogy I111 l'III'II~lIlaJ' MOiors, WI,I,I IS Ih,~ l'AIICCICd increrncntnl cn-h llow

1/"" }" <llIIphly the uce s"gllll), nou- Ih.il the J"r,"'c" (lmlr,H'1 will h. IIndC,l"k,'n rcg:ndl," 0' I u .. I 1" ":C, .1 the 1."",,1 ( ""1<'111 11dl pa",,, aml II, ill ,'''III\t, l'arucul:u d",'IIk, m mlLk~' ~m AUl.,ll'nlHUl 1....:1 r:1l'p'11H'

111.1' IF.DICAL 'LIN I('

Tho 10<1",,1 r"h~y Comnuuec "I \hl,' [erhcal Clinic " considenng adopnon of ~ rohcy on 'C'C"lIlrl~ lor Hlodger'» """""" A new, m ex pensive le'l ("IIII'd the Fox resr) I"" ILlst h"~11 1IIIIHlIlfL('",1 nnd some lI1"IIIIII"~, "I the c,l11'min<," Hrgu" Ihlll Ahle ,II"uld usc tILe le~1 I" screcu ull (lillie cl"01,'< p"""I1I" Tllq 1,(,1111 011111""1"" I"" ""'" 1,1111' $100 and is 1','II",v<l)' rehabl. WII" .. '''''',I'YlIY and l!",c,hcIIY ench of 95 percem (11M. 1', the falsc·po"U'c 'lIId fnlse ""I'IIIIV" IIUe' arc onfy ~ perccnn F", a persoll with the Ih CII.,', there " " ?5 p.,,,'111 chance ,i,li, ihc le~1 w,ll corrertly I\'VI' " povruve rcsun. and I, 5 percent chance for ,I I,.IIC nCl1nllvc 1",1111 • .)1I111]mly. r')f II 1,,,,,,1111 whu docs nOI have 111C II I:,ili",", the 'eSI will correctly give ;, nC~III"'I' re,,'" 9,<; peicen: "I rhc rune and" I,,],c 1""""" Ic,ull 5 percent: '1'1"'\0 proponemv h~. Ill":.'''' screemug . .uguc Ihal I here IS tilth:. diln,p.cl uf oj, nusdiagnosrs. s,nc(~ ,heu' is II ,et",,,1 II'" I h. Deer 1.'[-11].\1 "",I be "IIIIIIII"[CI ed The Deer I." rs absclure] r ,,'h,. hle, niul ';1"", ~~no, A person le'lllIg 1""'11 ve on the rn~ le" cuuld be given rhe Dec, req 10 cnulu 111 II re rl IfI,g nO~I:5,

1 he prnponen: ~ JI~UI;:' tun hl.!r I hw, rf caught at an rm I Y ',ulRe I I he 1 reatrncru en,. I'm OIOOIlCI\ d"c",,, " "oolll Sl.O(t(] I}O' I'".IICI\I AI rhe I""" ",Ir," nf devclopmcnc. Ihe <1"0"" IS rclnuvelv ""1' 10 detect. !\cneroll} hy "" ordinary merhcul cvum l lowcver Ihc ","I "I ""IIIIII!! Ihl' ""e,,," ", Ihl' singe" "lh'IiIlIl",lly nmrC-"bnLLI ~9(l,()Otl-.n pari I1c", "" " , IiI1 ~OIl1I', i'CCII'"I"~, there arc ICVl'J'(' """1111":,111°'" and" rllinlily III ""11' ,''';"~,

AI\OIhcl "'I,,,,hcr (If the ('01111111111'(' '''I''C""d concern ,,111>,,1 the "human cost" f r,ll!e pO~II""" lie P'"IlICd out Ih.,1 1',11,,111 0("'" gel very "1".1 "hen ,I Ie" resun ,s 1'0"" 'C. de'll'" 11""","(", lila' 1I m,IY he " fills. posruve. Evcn " ~ Ilem'rll 11'''C'POSIII,t rare ruuhl COlLI'" Il 1", "I """"Iy If applied III IL WltlC runge of Ablc', 1';(""""

TIll' 1111'01 lel1 I ~,r~CIQr W"S nOI '1111' IIItW In .ncorporarc rill IIIIN inforl11i1lion 'LL"I .llIaIYI,C the p",hlclII 11""<\,0,', >I IVa, d""llIflIIIIIlIl a,,), screerung 1'011(1 ,hll"lrj be apphed unlr",rrnly 10 ~1I Able paucrus Blnd~el' ,11'.,\\0 ~cneral1y affected pcoplc- '" rhe 2(] 10 J(] age ""'pc, especmlly men I he IlIghe'l mk glllup appeared to he ruen, 2!1 I" )(]. who expcncnced Cerlnll1lyl'~'\ III sulfness ann 1('1!! 01 rnolriliry In shoulder and knee In",I.\, AboUI I in 10 ,,,ell men hlld II I~oIg~I" disease, For rcnl'ie under 20 and over ~n Iht low ri~k gnlll p nul Y a/>nUI 2 LI' 10,000 had 310dg"l\ 111'""'" ~'" 'he rcrnainue. Ih,' mcd.u .... "'k gruup ,,"ly .. bout '" IO(] had the d,sca,e

to, Scl~"1 one ol rhc risk 11"1111" "'y, rhe rneduun grollr (wuh I In Ion chnnce I"r the dl~clI'~1 1)1',1'" the UIlC"IIIII III'" lor Ille prohlem Ihlll show, Ihe '"1'1011.\ leSlle."I" !'Inti lilt' (ICCII"IOIlS llHit Can til; rl\iHlc wang Ih!~ Jf111nHl<lIIlH1 I"du(jc lhe nu lC~(,j1 Cl.ISr' III VIII .. IfI'C Add Ihe 01111.11 I",vnll, ""d prub .. h,hllr, III Ihe lice ,IOd roll II I"'tk In tl"Io'III""" Ihe he!1 dct:""l1'

II 1"111 Ille ""11" """Iysis fnr Illc 1'11,(" IWo grlluIJS, Willi. IS Ih~ he" 1I11"rn1lllv,' II, ",1<'1, "'''"' Whal policy wOllld you rtl'''I'"11CII<1 for Ihe elll'I('"

;~;

, J

'J' 1.1'0 II " I I'" on Chnsunas I ve ,II the l-mergencv CllnUI~ (rmr, .r Telco, the S,UI I rnn "0 !lay Arcu telephone cm"I""'Y l.~rI y Neules, the mHnllger on <IUlY, has received ,'v~".1 reports rlOlil Operator Services 111111 customers arc hflvm~ ihllrClIlly 111i1king "all, (0"1 of lh~ir Im'I.1 (1"llllIg "rea.' Checking his dlHgl10Slic printouts 1""'11 kr.y !wllching OmCC!, L.1lr1 y con til 111' Wholl he h as dreaded n'"'' Inc rrouhlc " HI n,,~ 01 the three marine cahl'l' r(}\lle. c rmmlB San Francrsco HOlY

Wilh rnnrme cable" II" IW,cs""y 10 ideruify 0, qUICkly", possible which one I> ~~u!img the rrouhlc :H1d 10 ;s",l",l: 1111' unuhled location. Only "rler this ls done C~II 111~ crill! be rernutcd. The only wlIy 10 itlenlify which of the three cnhles ;, "I [ault (and where) I~ 10 d"pllleh a lug boat and .. rew III cx"mine each cable '" vclectcd uuervals and i'nl"l~ I he problern I hI' search process h," In I", done on a u ml on" er ror h."s, one cable nI " ume

I!:ilo "," prepared h), such un emergency A 1i"1",I"d "'LlI)' has heen I11MI. of Ihe three "lIhl!'s alld huw likely irouhle l11iglil occur, The ~1",ly ,""Ik uuo "ceOUI1I the ICll11111 Ilf Ihe ",1M 11111IC, the age of Ihr ,·,,111<'. "",I rhe number "I ""I'III"~ In"e< crossed hy rhc "hl,c Un'cd on Ihl< dam. lclc« " \.".<1 the probabihuev nr c .. hlc 'roubles as ru"uw, (we ",,11 1'~"UnlC .hut the: prohilt'nhlll'''' fm Iwn Or three c.,hlc\ helflg 10 trouble 'i1fl"uh.llII~nU"d) .1tC {"till

I .. CU;lIfrolP

Prnb(rhllHY "Jrmubl,

C.hlr I C.bl< 2 C.hl. I

Snu Fm.nclscn/O,j~ 1,1 lUI S.lll~o1JlloIOak l ... nd IIIIY"li.:ndlSan Fr.ancl(("n

OJ 11'; 02

1 he above [lrohah,hIiC\ ,nlrly, fn. example, IhM II Ihere " a cable m IrPublc u,' IllC' ' IIHln IWI~C ,J\ Irkely Ihal 1\ " II' ".hle 2 rather ihan III cuhle I

Studies are also availnhle LI"'I ",rI'CHIC the number III 'Ii II, liVe, each cable and lite revenue gcnc"llcd Irorn these ""II" ('I"i,",,"s Eve is. nf 1:0111 sc, II peak tirne for ",11" "lid ,,'Yr.II"!) 11"'c~ Will be signilicam II Ideo fall, 10 quickly isol.ue a uoubled cable. These life t',lIll1aled ro he

H~'·c'tw,. '0\1 ... ' ($000""" ",m,)

CIII,I, I r.hl,2 etblc 1

,S l~ 1)(1

I~O

III IlIcIIIC Ihe malfunclll1ninl' c3Plc. Ihe Emcrscl1cy ClIllIlnl ('cl1ler "" 10 ,j"",11 11 II I<l 1\ , I",,,, ,Uld crew. a •• cn~1 of '1,,000 per hour Only u"e lUg " ."ailab!c. The tIC w h,H to c~,"lIIne c"~h cable ,II lurn until !IIe fauhy one 15 "",llIleri r he Emergency Cenler'~ tI"~I~,on fIC Ililiel n I' 10 loli Ihe crew I" wh'ch order to ,ea re b

290

Pa~1 cxpcncnce mdicurcs lilal if a "able were defecuvc, II would I~kc the crew one 110ur I<J isolate Ihe delccuvc 100'011011, HI1<i I'CIO""l1g proCCdLII'C, could bcgm irnmcdiarcly IhCfcaf· leI', However, If a cabte '.CI'C not dcfccrivc. II wO(lld lake Ihe crew IW{\ hours In check il out COI11I,lcwly before IlWVillg OIL 10 the next cnblc, I'or example, If cuhle J were BelLlHIly the defective one, bill the crew examined cable I first , rhen cable 2 before go;"g OIL LO cahle 1 the roral search lime would he five hour, (IWO hOIlI'S In check 0111 cable I as OK. ''''0 hours 10 check OLl! cable 2 as OK, and one hou r I() I solarc i be trouble III cable] I,

a. Draw a decision tree Ihi:tl would help the Emergency Center rnanager decide about the order in which rhe lug crew should cxarnme the cables. Include probabiluics in your tree. (In the cnses wher-e a cable has been searched and found not defecrive. assume ~ba[ the relative probabiluics (or me other two arc not changcd.) l nclude [he evaluation units (payoffs) tLI [he: end of branches n[ ynLlr dccisu.n tree. Assume Ihm Telco is willing 10 use the 1n1,,1 cnst (revenue 10<1 I,l", 'Llg and crew cost) as <he relevant payoff measure

/>, W hal seurch ~1 rnrcgy shn"ltI Telco "se','

Solutions to Practice Problems

6-1. (I, E"P"CI~~ nlol1e,,,,y value

[venl p,EI'em) Acll Au, Atr .l
;\ ,35 1.4 1.{)5 .70
13 .'i5 I 8 2.70 22~
C .zn ,8 120 I 60
EMV' 40 ,195· ".55 tOI~tlmlln1 net.

I"~ Expecled opper,,,n; I y loss

Evens Act I
1\ II
B QO
C 80
EOI. I 10 liel ] Act J

-----_.

J~ 10

04j

.40 0

,1.1' I I ~

"Opumum ilL.:!

c.

COIlrJiIUlJW/ Vii/Ill' IwdCf Cer'lruPtr)1

---_

1\ II C

d.

Ex peered
II....,JJre
Condmonot under
EI'efH P(hc"'1 Vet/fit' Cc_~uli~~
1\ ,J~ 1.40
B .45 6 2,7()
C ,10 A INI liMV.

j,70

e, Hxpccrcd 1l1t",eI<U'Y value u,,(lcr cerw1I1<y 5,70

E'pccled rnonetary value "r optimum aCI 4,95

EVI'l (also the I~OC of rhe optimum act) .75

6-2, G, Since there " on penulty loss for unsold copies, the operator shou Id order al least 14 Or more copies to make certain all demand is satisfied

}, See Table 6-23,

(1-3. Q, Sec Table (,-24.

Expected Prnnl i., S80.000

The be" O1el is 10 ; ru rod ucc I he product.

b. See ·Llhlc 6-25,

The LO,VI'I 's 20,000: <he I;,OL of the best act:

c. The RVI'I would rncrense [rnm 20,000 In JO,OO(1 'nel Ihe EV Dr rhc be" ac: IV "Id decrease Irorn BO.Don 10 flO,OOO, The Ilmlll under ccrwinly would be <)(),OOO ; nstcad "r I oO.non. I, V PI i ncrcases OCClI Lise the possible expected loss assocratcd wuh introducing the produc: IS more serious.

2'91

TAIlU.6-23 Expected value tnnle (P,·ohlem 6-2)

A"f.l .)lOck
10 /I I Z IJ 14
------
Ewmr P{Ev''Ir) eV EV ev EV Cy EV ev cy ev EV
Demand 10 10 2.00 20 1.70 17 lAO 14 I 10 II 8U ,08
II .15 2,00 30 2.20 .J) 1.90 2CJ 160 .24 I JO .195
12 .20 2,00 .40 2.20 .J" 2.40 48 '1.10 .42 1,80 .36
IJ 25 2.011 50 220 ,5.1 240 ,60 2,(\0 .6S 2.30 575
I" :10 2.00 1i0 2.20 ,66 240 'n 2.60 .73 280 .8~
EMV' I,()(] 200 215 22.1 2.:10 l.050
The hej;t OCI under conouions [IF zcrn salvage value IS "SIDck 12," TAUl.~ (,...24 Expected value table

(problem 6--3 a)

T,\uu: 6--25 Ex peeled loss table

(Problem 6-31»

A(,I.~
Do Nor
III lrnd.l cc 'IJIJ'oriJtCe
Event tJ(EIi(!rlr, ev' r:v ell Ell
.10,000 dorm 0" .05 (200,000) {11l.OODI 0 0
40.000 (Iemana ,10 (IC1O,OO()) (IOl)OO) Il I)
50.000 de mn nd .zn 0 n 0 0
60.000 demand )0 IOO,DOO 10,0()O 0 o
70,O()() demand ,,5 20D.()(]O 70.DOIl 0 0
1.00 F.MV RO,OOO 0 ·CILlcuIOi!lfill or cv

)0,000 ' $1 (] - 500,0011 " (2UQ,(~1II1 .10,000 ' \ 10 • 500,1){){) ._ (IOO,O{)OI 50,1l(1(] flCl - ~OO,()()[] n 0 110,(100 , .110 - ,00,000 a I(IO,IlOO 10,(I(I{I' ~ 10 - 'i1)(],ODD = 20{),000

ACfJ
'Ijlrot!ur.e I)(J Nor 'll't'odra;J!
F.'W:III P(t .. »e " I) CI. st. CL 1:1.
-----
)O.OO{) <10",.,,,1 ,0.1 :W().O()() 10,1100 o 0
40.0()() <lem.,,<1 ,10 100,000 10.000 o 0
50.000 dernnnd ,20 0 0 0 0
60.000 demand ,)0 0 () I (HUHM) )0,000
70,000 <lomond .is 0 0 200,O{){) 70.000
1.00 20,O{J() 100,000 FU:IJI\I /, 1'1 (Problem 6-4)

PrcduC:1 B

\ r"O~UCI C _

High Siiff"lti (3)

lm, .. sa'o~

P)

SH' hI~lh 11 r IL.II

E(.,,"" '"''

H.gh sal". 1.4)

Low n.rllMI I 6)

Hlgll solo&

~"ala,- 151

NO! Hl(:l"lIllln

f~1 r1111!10I111)

00

a o

'0

o

.0

80

40

o

'0

6 -4. The Opllln'" ,Irnlcgy is 10 uurouucc prelllLl,1 1\: <CI n lnw priee Ii there '-, a II me dcl,)', "'1 " hi ~h pnce ,f there " nil lime delay The e 'pel lell net P" 'h' "

SJ 18 nlllll,,,, fhe developmeru of 11l~ 11< -r- 1\ ,I"""n

in 1'11:'"'' I, 1<1'

~-~, " .'leu Fi I\ure 6-15_

/, I'h~ firm ,h~uW bUIJd the small r]~nl Ilnu c~p;lt1d il

I r the pmmnl ion effort Ci'lpILJ n:5: il ._ I~ r, IIH':~iJ11 ~tm re of the rIIMkel The expected nCI pm!!1 " "\ I 11111100n

6 -I,. W,th ,I pnor prohabrluy 01 (I ,I In, ,I "'0'" mu, you WIl" lei 11111 '~II l'hni is:

"I~ 8 ruilhuu) oj ,6(51.:1 milhou)

~ 1 1(\ niilhon

wlu II " ," C,III"I ihau S 1.0 million -I" ,e",," the prmr probahihly (lei /I

"""~I

lind dehl'

28

Higl15AIj)fl (-1)-

Mea. sales I_51

Lnv, sale_:!=; ( 4)

~~I'Hlj nsr
Suw· ,11',0' I1II Pi/lip) IVIl I'i 1'1,,11'1
Reecsvrnn I _H 11 r\4
Norm,' 6 3 I~ ,11,
p(fll III N",,' rl ",,",,Id I", WI,e 10 sell. Thai 1.<

("I(~ X ,,''''1<'''1 ~ lIi($1 ,J rnilhon) wluch " I~" 111.111 ~ I n nulhon.

(,-1. T iI~ pmh.,nllily or Inc Ie" CC'" I, (Ill<" III'" ",11< with 01,"11 er n 1 Ill" :I" II) " '10 . '" rl Ilic ,J,<c .uc

~ 9H ILLlII"",

,: /,' t'

r,

I'II.tIlU, 6-IS (['1'1I1lI~In6-5 )

19J

P,ufll ($mlll'o~"

Small plnnl

o

S,qnlfl","LI{

-(;;-/.'"' a s "'""'''''".

a /\.~"",," -(,6)

loaded. ,,"d '/0 . 'I, i I I h"~ ,II c ruu Call I he Ie." rcsu II .I" ;",,1 II,. stare (I<lwlod Cit nOli I' 'I'hen

~( $1) f \SJt = S-~. If nru 2( ~ll I 9~{511 = \~ 'I ~ 9 'I .,

li(Vj' ,5"( -n .. ,~(.(~) "t17 IJOI'" play,

{, H. ~"c Table 6- 26,

I" hl' Ih'i~IC.. IUt proh.anjjil'C!li .11 t'

"ISII'i "/5.1'1 1'1/,1.1"1
CY 11 175 1.1
~ I S I
(~) J'J Id'
11,
~ I 31
1'/.1'1 .112
81 J

.fl9 /'(/.I,\'I
P(MS) = - ~ 10 .st
.23
1'(Hln =:!1- 1() /'(1.111 ,70
50 .
.06 I~III)
p(HIF) rr- 17 n 7li ·1· ... IILle 6-26 Jojnl P"ohabiIH\ Tnblt .

(Problem 6-8)

r~·~ t'I I'J J/j 'I' 1

III~II Inw

M.'8m"' rml,.~rl"y

.\rlr' ..... I"rdu'llIJl
SIIU-I"'.!I Ir •• tJW'IHllr' j"ClrIJlf'I'
.IlY ,I ~ 06
I,j l~ 21
H sa ?1 M.'t,\Jth~1 f',jJIJtl'lrllll

111 1(]

100

194

The dec.sicn nee rs shown in F'g"'" (, Ih

l he sur .oy 'hnllid no, he taken. srnce .h" ""' vnlvc is rlC~nl'"C ( a,I12) 1 nus, rhe w" "r Ih" \,It VC)'

01 ~O,2 11111110n exceed; the ",p"~",,, vuluu I wluch " 0,2 II In '"' ~m~ ",ill;OI1I_

(,-I}, ,~"" Tal,'e (, H

T h C 1""1" "'" probabilit ies arc

The nee " ,h"",n III r'g,lfc (,·-17

" Sec "PfH'f hl,,,,,,he, III tree \\.'"h"". the \url<'y. II", pro.I",:1 shuulrl 11. It" rocluccd lhe ~~ 1'<110(1 pm!.1 " $1 ,() ,,,,11,,,,,,

b. 7,c.l'o. A'!, cnu I~c !'OCt.I'. the survey never c:llim~~'!'i Ilw deo""", ", "lIl1,I1U{C the produc: (in ilw ,',,,,' ", failure predtCllon cUher j]C1JOn ha~ I hr 1j~11H"'· expected value], lienee .• he IUf\'CY h"' I,n ".,h,(· I he com P"I1Y would be wasung 'he $. ~ mil II lin ,n"

(P,."I,Ic'1II (, I))

I'rolll

(!~ rrllllions)

$nlr,-r. H14"

~5)

\~"'"

1.51

~rlll or I L I t;ll P'OU"CI

--E~ No "'lIod"citon

.0

-20 o

"(/11.1'1 I'(I-II/) 1'(1111'1

1O1 2~ - 0_80 21l1,4~ = 0.44 101.)0 = 0_33

!'eLlSI P(I.I{) PiLI I"

O.V 2~ U,20 l~1 'I~ - O,~6 :!1l1,1{I II (>7

38

r-, 10

-22

-07

To"o 5UIV0'f

III~I' .,,10" ( 31

22 -lJ2

Plg!" (Smlll,u".,

Sales

J,B

E><f!t=

l61'-CI _

~,O

-2,2

-<l2

[

H'gh

(o~-

)~.-,

_t 791.

resl

Inlroduoo

()~~

~ I01rmhrrllul\

1211

TAm.I', 6- Z7
Joint I'mhahiH!y Pmt"111i(lI S.I r , ..... ) p~·~tt.(,lm/l
Lr,"d oJ Mal",NffUlI
Tohle StJJl'.t !j;~j(Tt'~~ fm::mtdm'lt' Imlmr: P~nfmbjbly
(Problem (i-')) ------
I-ligl, (1,,1) 0,10 010 115
Lnw 0,11.1 O,lj (1,0 0,5
Morgi"' I ~,,,b:lI,,IIIY 11'\ 0·1; 11 10 Decision and Risk Analysis at Du Pont

------~ --------

Mol ivnt i rig Example

D11 Porn. one or the world·s O"'Jllf producers or chcmteals. .s .[11'\;,0 involved In oil. medical. ag nculturul chemicals and other products. Dec ision ;fI nd l'I~k analysis has been used rounnely OJ 0 u Ponl 10 cvaluare strategic decisions [or the various divis.ions and product Of business groups;' The comp(1ny reports one specific application for a business group thai had ~ saiisf .. ctory hut declining financial performance be· cause of loss (If rnllrkcI share "",I decluung prices. 11 project team Will': formed tbill wru ked wilt, Illflflllgc mcnt in various parts or the husinc!ts, F(lI rcnsons of confideuualiry, specific rlctuils Olf tile prodects Me not available, but tile product, were manufactured in the United States. Europe. and Asia end distributed worldwide. The first <IeI' was to properly rrHm(\ tile problem and develop the alrernaiives. Two srrurcgies (plus rhe base case .,wr", q'lO) were selected for study: a product dirreremiati['Hl Slrategy mvnlving new product inl rnd ucuon. and it cost leadership Sl rntcgy

L____ __

29(,

involving producnou efficiency to 'lcIHCVC lower priccs An influence diagram W'_I~ developed to idcn(ify the import ant fac,or, affecting pmlitability with ! 11C$C 5 uaregics. and I he probabil i lies associ nred wu h the unccrtairuics were 11ssessed using group.~ of expens within (he company, These rhrce alternatives were examined in detail, This involved calculating the curnulnuve probahiliry d"rrihLltionllO assess the risk:

Sensi [i vit y tl.natysi S and value of infOl' mill ion calculnrions were atso performed ro [urthcr undcrsumd the unccrtninrics AfI'cCIlng Ill" dectsion 11 '1rn'.gy w:IS ChWiCt1 thaf i~ eXp~C(tHJ 10 increase rlus business "",1"., value by approxunarcly $175 t11 ill iOI1 when i 111- plcrnerned.

'See F V, Drumm and C. F. Rolle, "Management and Apph<:a! iOI1 of Decuion uud Risk Analysrs 111 I)'LJ Pnnt." t oterfoces. November-December 19.r~2. pp, ~.:l_q"\

,.

:,

v

CHAPTER

7

----_._----

DECISION AND RISK ANALYSIS

The nusic elurnerus for decision making under uncertainty were introducecl In the rrcv ious chapter. ln r~ rl icu lar, a dec i sion rna kcr has a set of al tern a [j vcs u nder consideration, uncertain events can occur. anu there ls n payoff associated with each combination of alternative and event. Probabilities are assessed for events represe .. Hing the likelihood of occurrence. If the decision involves a sequence of decisions or events. a decision! ree can be drawn 10 structure the decision problem. Finally, the expected monetary value (EMV) decision criterion is used 10 select (he decision with the hlghes: expected value.

The EMV criterion is a sensible guideline in a great many decision s iuiations.

In particular, if the amounts of money involved arc small or if the decision is a repel i ti ve one, such as in vc ruor y sroc ki ng pol ic y. then til c ex pee ted va luc cr i terion i.1 likely io he adequate. or course. "small" in Ihis context is rclative-c-decixions involving lens or hundreds of thousands or dollars arc small for a large corporation, bUI would not be small for most individuals. However. consider the foll(1wi.llg examples:

Exarnpfe

Assume (hat YOll arc given a choice in each of the following paired altcrnat i vcs. You may select one of rhe A choices. one of the B choices. and nne of the C choices. Make a note of t he set of a lter nat i ves you choose.

A, = The certainly of or Al = On the flip of a fair coin, nothing il" it comes

11 $100.000 gift. up heads. or a tax-exempt gifl 0($250.000 Ir

tax-free the coin turns up tails.

B, No gain or loss (If 81 One chance OUI of 100 of incurring a $9,000 debt, and a 991100 chance of winning $1.00.

c,

A girl of $10.000. tax-free.

A payment or 2" cents, where N is the nomber of limes a fair coin is flipped until (ails comes lip. If tails appears on the 11 r,1 toss. you rccei vc 2 cents: i r I he coi 11 shows heads on the rirs: lOSS and tails on the second, you receive 4 cents; two head" in a row followed by tails yields 8 cents: and so forth. However. you a re allowed [0 par I ic ipate only once; [he seq uence stops with the A rs: show; ng of tails,

297

N1NTII [!'lITION

Q'UANTrrA~rIVE ANA,LYS[S FOR MANA -1MENT

Charlex I~ Bonini

Will",,,, /I, Timken Professor 01 M"""/:I'lIleIH Science C;rll(hwtl' 5,1.00/ o] Business

Stwljl)j'd Univcrsit y

"Vllrren H. Hausman

Professor 0/I",h1.<lr;01 EIl,~'i1CI'rI/J,~ ",,,I EIlj(,neerillg M{1lw,~<'m<'f11 {J1'/JIII'IJJ11'1I1 (lJ Industrial En}!InI'('I'i"II'1tlti r:11.~ineerilifi Mrill(ll:f.II'~1IJ S"iIJ!"rr/ 1 Iniversity

'1lamld Bierman, .Ir,

Md",/(u /I, Noyes Professor (If I/",IIIICH Arim;tliJlrllllol1 Jol",.I'(!JI Graduate 5,11(1,11 of Mr""','II·ltll'lII

Cnrnrl! Un /vvr"ir y

1~I,rwin

d..lfilW McGraw .. Hill

BI1SlOll. Massachuseus Burr RIdge. Illinois Dubuque, lowa

Madison, Wiscnl11ill New York. New York Snn Frnncisco. California St. LOllis. M issouri

MOli,'u!illll E~llll1plc

Three Applical ions of SI mulation

SuuUlnli,," i, applied In I v,onell of Sl'le"" ,0 bu" OM' ~od the public sector I """ very large '0 sruull operunons. Here are I nree epphcauons selected out of ! be UU.lI1Y presented f11 Lbt! nnnu :11 WinfcJ" Spa Ido I.on Conference. December I~Q4

I 'nrBlIIQUIl I FHrlT! ri~t,'ch In Nut Prod II cuon'

1'1"'lciIIO IlIILS are 1,n1'.""",1 r,n'll trees and 1111'" huuled Il) truck 10 " flie ,Ii'l y Cd I led ,j h"I,Ie, '1',1,,· ""I S go II" ou ghsevera I 'Ie 1" we, 811 ru, pre clcamng. h" II

I ng, dry I ng. Simi ng, sur Illig, r("'\lII1~, drylO!: ,Inn p~"k"[,,ln~, Paramount I-'lIl'In~ wi~llu,1 to increase pm ,I"" I inn (If pistachios f rom II,,~ CHI rem I evel of 5(, mi I h"" pounds of nulS by 2fI percent over a I wn·yrlll non I.on and by 40 percent "vel f"uI years. The III'" developed ,,","'""0" mode I. lor II~ I wo major Ill' II,n~ I "e,l, "c, The." model s I rildell rhc n "I, I h rough I he vsu IOU:" steps and i ncluded rundnm Of uncer t ain blr.· InJ'r;. .r:.m:h ail;" truck nrrrval ... Ita""ed nn the sirnulnnnn ,In nly"" the {i,m ,d"nnf,~d !h~ h""l~,,cck' In I he pm I..·C~"'I MLd derer rrnned IIOw In rct:oul1g.lIfC the t'.x:I~llllg "'I" i I'''''' III In nl113111 I he IIc<'"icd 2(1, icrccrn increase III c"I""'''Y Si1l1iJMly, II,e lirm WI" "hie 10 Jercruuue wh.,( ",,",mal equipment "",',I Ill' ,,,Itlcd In nbtnin the go," of " ~O pcrceru nle, 011'" "I <>UII'"I.

I 'nrt 01' Sing<lpor·cl

Singapore I. a m. J or hu h r Uf 1"1'" he Ocean co nl~' ner traffic. Wi!h over II mil II,," contai ners 10 1l)9~, Smgupore is " very ciose second 10 Hong Kong' nih" "'or Id in terms of nu rnbcr of cOI1I"i ncrs "a "died. Ovei I he I'n'l rune yea", rhe Pori of Singapore has 111 c reuse rl I he number of cum arne rs ha nd I ed s ixf 01 d wll,l. m,," IWneousi y r",lll"lIl~ d," work rorcc hy I I percelll, Tim ,pcclac,1I111 jlIOIIII~lIv'lIy gain Il!l~ b~e,. neotlll1pli,he,1 pnn i lilly I 'Y lIiV"~lll1C'" i 11 Ille 11111"1 I"mlliing cqu iPI"CIlI ;",11 III [01 lila! um lechnnlu!:l'· I !lll

I Y Dt:~l'HnJky, G Mt'lg~.oh, IHld 0 ~ I,dllll, "1\ 5l1nU!llllon /\11111'C'Hlch In C.,paci[y E,:\rnnitll,ri rnl 1114:: !Jj!1L:H::tllfl l'ILII,IIII,Io! Il,nc:.c'S~," ftOci'(!di'lg_~ nfrlw I'Q(M Wjll/rl' 5ilrwlmiml r.f~n/~lt'Jln'

'I' ~I Koh. I L. K. Koh. II 5 i'J~, ."d H C :-<g .. , U"n~ !!i Hnu I Gil 0 n to Pre'" ie 'iN P In "iii of II Con [;Do mer Por' 0r'Cw'lon," rroce~dr[r~;r 1)/1"(' 1r;9/~ WIH1CI' SW111,/MW'IJ C'-lIJ!flr(!IH;~

4111

Ihe 1m'! managcmeru h", .1", been a very ad, "'Ke,1 uxcr of the quonlllallVC techruques d'cscnbed HI I h" book, 0 r parucular nute " II srrn u I 01 ion model <1,,",,1 oped In analyze ihe opernuons rn deta il.

I 'on npcrat inns srar: with IIl~ arri val of a . 111 I p, "'I,,~h " ~lIocaled a bellh ,1<1d a number of q'''')' rrun .. for unloading, ('nnl"lIIc" are moved f,om Ih" 'I,my C'''''C by vn nil k"IIHilLlI cnmers called /,"'11"" rHOVt'J'S (PMs), The CrmlUIH(' rs ilrl:: f;CIlI to ViH"lOLI ~ p,11 I' of Ihe ~llipy"HI wl'"1 e Ilwy Me hand led by Y"" I c '""C' anti srackcd "" In ,even fCCllngh The 1"".<" I, reversed a, the slup I" r~I'o,lIlcd wllh outgo: "B con 1111 IWI> y" rtl cranes 10 I'Ms III quny cranes IQ ~hl 1', Willi" I Ill.' is goi Ilg 011, II "ck~ III ri ve 10 deliver ;1IIt! I",'k "I' containers 1''''''1 Ille ""I"de. Also, there " 1,,()Vemenl of comamcrs "(lIn II rhe yard 10 make II""" more c",ily avatlahle for luturc ship loading,

I',," sunular "'" model capturus ull of this arid 01.

Inw!" the planners 10 fOpO' hnlllcl'r.!l;k~ :811d to make ch""A"' in sehedul,i"p ;lIld ,.llocai ion of '''OU'f,', ""~h a crane, or PM,) hd",~ the bonlcnecb lIeUI 1111 y occur This mmlt I " II "gM I fico"1 part nf I lie de CI"l IOU ,.,uppnr[ :::y\lt:tl ~ fnr tilt pOi l openu ion!o.

['''"11 !loll " EI chrun <II ,1"",,1 ",OI1() ("51·(00(1 rc""" "1"11~ worldw ide, PI',W Idlll~ gl"'" customer scrvrce ,~ il rhnl h~nge CU,l.IClinC.1 .u II vnls fin; raudom ..., 11[1 \lUI "i ,IUIIII& rhc d.y. Cusrarner Ollie" ale also random, ," well J' the rime needed", rake I he order and III pre pure II. Walk-in OIl51(l11'~I" huvc different order pili ic r 115 rha n drivc-th muU" ones. And, as new menu ucrns are inl reduced, Ih~\c paucrns change.

i""CO Bell hUllt a ,j I"ul~"o~ model Ih"1 Includod ~Il 11l",c "iemenlS "ml I hnl co"ld he cu,,,o",lled for ~a.;h L tHililUl iml. It en nhlc:!i lhe II'1m;.lgl;.lf 10 dc.u~,rrrllnc 1 hI(,:. ,1111'111111 of I~bllr nCl,dc.lln IIICCICII'lomCI' rc'l""'" meol' and how 1(1 "1~"IH,e 11';01 labor (how In 1""1'" In ,k,. rm c~" III I' Ie) rI'e mudel h a' been I rnl'l~ m,'lIIo d III II", I',,~u Bell> ,II Ih~ \/l11lc.1 SIIllC' "Ion "",m,'le,1 '1IYIIlgS ~f $7.6 ",illl"o 1"'1 yl'lll 111 I;,hor Co.I!',

'M Gndw.rd and W S"," rI, • A" ObJ",;t 0,; 0" led

S Imulill On Model for [}~I~ r I n I II Ing l...1bor ReG II IremC'nl~ II I' 1';[H:n Bell," Pmt:e~dlllg! fJ! rlu' J ')04 WUJ/er Sj III ulor IIUI Cmlfl",I'"i"n.c~.

.r

(' II APT E H

10

SIMULATION

Sunulnu QII I"' pi k., huihli n,' 0 replica of Wine r~,11 Sy' tcm ~ nd u~, rig 11 under lC'1 r!llHlll mn~, Thus, cnglneers ",ay lCSI OUI models 01 new uircraft m WInd I LIi1'H.d", <Inc! uuline pdOiS and n.,II·OIl,IIII.' Ir~ill in niglll ,;lnllh'lor', 111 managerneru, muthuruutical models arc constructed ,lIlIl I"cd 10 test the ,c,ulls III' decrsinns before Ih~y Me implcmented rn actuality In a general way. any model of a business decssum prnb.ern could be ca lied a "i rnulnurm, since i I represents or SIlIiU I ~IC~ some "~PCCI! 01' I he real problem rill exa m pic, a li 100'n; program m i ng model miry be designed 10 re present a pi mlllri mix problem or u rransportauon-plunrung (11 nblern. The sirnulauon IIlt1dd< cunsrdercd In 111L~ chapter rhffcr from other models '11 three re~pe{;l~

I, S I rnu lation Il1IJJd~ n I ~ typica II y not dc~ I ~ IlL!!! 10 II nd Opl i mal or h\~., I Siliulions, n.' in linear programming or Ik'~i~i(J1l ~11;dy,i." I nsicud. scvcrnl I'roposed all crun] i vc~ Me eva lusted ~ nd a (kt'l SII111 ,~ made Oil IIw 1M \i ~ (II 3 companson of I he resuhs In other words, I hcy evaluate pcrformnuee "r

g rven prespcci Fied ~ys IC",~

2, Simulatio» mod.'I, [ypiclilly focus 1)11 LIo~ dClilll~(j npcrarions. cillIC'r physical, I'Ir financial. of Ill(' lySI~III, T11~ system i, ,11I(lIcd I), il operates (jVcl 11I1ll'. and the cffec(, OIIlIlC urne penon's resul« on Ihc "ell 1 are included

1. Random or prnhalnlisuc elements arc In"tldcd In the srrnulanon models In this chapter, Th is inc I udcs exam pi es of queiu ng systems, j nvcntory SyMCIJl~, und risk analysis nrndcls. OflCD called Mellii(' emir; simulation.

10 IlluSHalC Ihesc ,hffcICIICCS, consider building ,. model of a raclory Ihm proth,ee! " ~cl'le~ of prodll~" /I Imenr programm,n~ mlld'c! mlghl devclol< Ihc ollllln,ll jll'Ildl\~1 I"ix, A fl10i"~ dClJllled Sil'HII,lLion nlO(lcl IIII!',III IJC concerned WI!ll 111[' ~"c~lf· I~~ (If 1"1w Ih~ faclory i, ~('llcdl1lcd to iJcllicvc lit(' IICSlrtl1 "m(lllel mix, Ink iJlll into ilCCOllnl nmchi nc SCIUP IIIIW" wm ling lime hefore jlrocc~~"'g, 3 nd (,I hcr dew IF- Illal ~,,"nlll he I nd uderl III the' II nCiI.1 progra mmlng l<lInnd,,! ,,,n

Probabi I ist.ic S illlUhllion

I" many ~llua!ionl, ulI~cn",my pl"y~ a key PM! II! Ihe operations or Ihe SYS!CII!. Jnd II IS importanl In lake 111'~ ranciomne" imo JCCOIIIII III 111e lTIodel. Wailing, !l1I1~ plohICIII, CUI1 he analyzcd by Imildi "/1 such a simulalion 1!10dCI Where we cnn ;I"dequal~ly

.HI

412

solve the problem by mathcmarical methods. it is generally preferable to do so. However, there arc many queuing (Hili] other) shunrion: that cannot be solved easily hy 111[lt hernat iC5, a nd hence. we resort 10 si !t,.,I:LI ion.

Example I

Consider a warehouse 111m has one dock used to unload railroad freight cars, lncorning freight cars are delivered to the warehouse during the night. It take, exactly half a day [0 unload a car. If III ore than two cars arc waiting to bc unloaded on a given day, the unloading or some of' the cars is postponed until the following day,

Past experience has indicated that the number of cars arri viog during the nighl have the frequencies shown in Table 10-1. Furthermore, there is no apparent pattern, so that the number arriving on any night is independent of the number arriving on any other night,

This is a onc-channc) queuing problem with an average service rare of 2 per clay and nn average arrival rate of 1,5 per clay, However. il can be shown rha: the arrivnls arc 110t Poi,lson: helle,' , none of rhc s!anclard queuing models apply directly.

The Flrsl step in simulating this queuing [1mcess is to generate a history or lime series of arrivals for a number of nights, This is done tosing a randomized or Monte Carlo process, One way to do this would he to lake 100 chips and write the number o on 23 of them: the nu mber I on 30 or them; the number 2011 JO of them: and so on. corresponding 10 the frequencies in Table 10-1, We could then draw a chip from a hat. and the number on [he chip would indicate the number of freight cars ~rriving ina given simu lared period.

A simpler procedure is 10 lise a table or random numbers. such as Table 10-2.

Each entry in the table was drawn in such a way that each digit (zero through nine) had an equal chance of being drawn,

We could then assign two-digit random numbers '0 each of lite possible ourcomes (i.c.. to the number or nrrivnls). as shown in Table 10-3,

There arc 100 twa-digit pairs of numbers. NOlc that 23 are assigned to the event "zero cars arri Y~": 30 10 the event "one car a rn Yes": ]0 to t he event "1 wo ca .-,' arri vc": a nd so 011. S i nee each t wood i gi I nu m bCI" has a 11100 chance of coming \I p. the probability that the event "zero cars arrive" will occur is 231100. or [),2], as desired,

We arc now prepared 10 simulate the queuing process. This is done in Table 10-4,

TABU: 10-1

Number lJj Cars Arrn.lm;:

Rehnivr rn:qucm:y

o

(I ,] 0,)0 (1,)11 (1 10 n 05 om 0.00

1.00

J 4 5

6 or more

Average .. 1.5 cars per rligh1

TAlll.E 10-2 Table of RHndolTl Oi~ils

TAIlLE W-J

413

51 04 R6 ~ .. I .N ,1/

611 6.1 1,1

Q.1 20 ~(, 12 42 29 1(, ~I ,I 5·~ 6K 11 53 91 ,IR .16 5~ 70 ,1R )(, 9~ 50

'I, ~n (,) ~~. 76 M 02 5] 16 16 :'is ).~ 2J Jf, .~ 71 a~ 1,

10 .16 ';4 88 00 n (,_1, 77 6'1 4U fIl 11 (,,1

M n .11 [IS 27 1.1 ~rl I() .\4

12 15 I ~ 12 10 8:! 74 OS 01 69 JG 1:; .12 99 ·'1 ,II ,,~

II (/1 J6 24 12 SO HI oz Sl 4~ J(, R2 77 54 21 J~ ~J 2,1 III 1i6 25 91 29

II 91 9~ .17 28 (,1 )0 .13 9 I (,7 97 iii II .If) H6 ~ ~ 0(, f>0 SO I? SE 25 ,- 68 .17 JR )1 00 .12 75 21 ·17 '10 JI ~.\ RR 1,1 2' 61 19

~o 2" 16 .12 72 n 16 ~ I 70 16 .10 :\9 :;9 74 R3 '10 68 14 ,12 47 94 19 (,0 61 89 10 41 05 22 4] 0<1 9.1 97 84 84 84 3S '12 04 2('

~ 1 )9 % .[/

77 26 9,1 10 5~ 11 RO (,<1 RR 69 1tt 07 10 08 ~o 1(, 5S "I) 69 ')0 RI II 1(j ~5 C)2 R,l RS ,R 11.\ 09 (,I 'n ~) .15 05 R7

~(, 1,1 (,7 (10 79 37 85 24 I s 36 )2 16 17 .12 01 19 02 12 OB 0') 80 40 07 11 701 S~ ~7 )) 77 70 81 ~7 (,1 .12 (,2 67 25 17 75 27

HI 02 60 04 'u; 3 t 67 25 24 10 ~o 02 ]9 6R OR 59 6(, ~o 12 6" 79 .11 86 68 ~1. R9 so 11 62 16 36 .19 18 82 t:l 35 .J 62 20 73

Nii IJJ [WI (~I Ctu ~ Al'lrllilp

f) I

Ul:IMI\'~

Rrnrdom D1tr;i',f FJ'eqw:m: ~'

--------- ._-------

(101022 D '0 52 53 '0 32 ~J '0 n <JJ '097 q8 and 99

0.:!3 () ,10 0,)0 f}10 0.01 002

1.00

Tllnu I()-I Quelling Sy~tclII Slmulutlnn

Onv Nlrrjllwl'

.r

10 II 11 13 14 IS 16 17 18 I 9 ,0 21 12 H 14 25 :26 27 28 29 ;lO .\1 12 _lJ _]" )5 ]6 )7 ,18 39 40 ·11 ,,2 ,13 44 "5 46 ·7 d8 49 SO

Totals Average

Hrr'lllrJIJI NtjJtlhl'l

'J'! 02 so

Nflllt/H'l'fl/ AfI/I'tl/.\"

.j

()

n I

n 1 [I I

n I 2 1 II

u II

r0101 NU'llh.:r ta UI'1' (hllcurded

4 1 1

1 II \

I o

l o

(, 1

MIIIJ'U'I 1/l11",,,!0(1

N~",ber f)elay,d In H}II(}wifr~ !)"y

1 o o

o

I o 2 1 I

I o o o o I o o () () n n 2 n I o o o o 11 {) () {) o o

I n

o 1 2

n o o o {) Q

2 1 2 o

n n () (l o 45

OQO

.j,15

TIII"l~ day~ lire ",~d In ,Im[ the process (11Il1rkrd II, For [he fir~1 tl"y.ll", "",(I"ul number (i.rkcu 1"10111 Table 10-2) ls 97 Sim'l' 1)7 rurrcsponrls 10 rhc CVCIII "fOIlI ':1,,, 11I11 vc" ill Tnhle I () 1, we lis: [our in the IImd enllllllJ1, or these fOil I cm" 1'1110 JIC 1I1l10illbl, ,11111 the unloading of the "III~" I \'11 I, P<1!iIIJ[llLed unul 1 he rolln"",lIt\ 1I",y 1 he random number for the second d"y " 02 (agalll fl<",1 Table 10-2) Th" 'lIC 111\ /ero cni s ,II"~C, "nd rhe IWO cars from the I'rcvlnll~ d~y arc unloaded We crmnnue In Illc ~,I1r1C fil\!lIor1 However, we do 001 COIIIII the results or the firq three da~" Ihl\ 1\ Ih~ iniliulb,nl inn period. The simulano» SIUfI~ Willi 110 rreighl cars. winch '.1 nOI I ypi~al ·1 he I "III~ lila I ion period gi ves ihc ~ i: In ulauon a cha nee 10 reach I y P i(';,1 111 "11Cildy suuc" behavior before results nrc cuuntcrl.

'1:11111' In -'1 sunulaies 50 days of cpcrmion (In udduion 10 the Ihr~c duys In ",CI 'larlcd) DIIIIII)t mOSI or the period, lhcl C I \ hule delay. Note, however, I h .. , I hen" " cnnsidcrnble del,lY srarung around penod 1(, I he IIVCril&e number 01 il" I "al~ re' <Illy (I ~R) IIWI 111~ s.uuple pcr.od of ~() d,.y~ " ~ligtllly 11Irgcr than lilt' l'~I)'Xll'll number pcr dlly (1,5(1), On the nvc,,,w', II lJO rM~ art delayed per day, 1101 Iw,n' flCCllIIIII' 11:""11,,, Ille "i"'IJI~,ion ,110,11(1 be t;1\I1'i~,li 1111 fill' more days

Wu ,.,,, lid me the simulation model in C!lIllllalc Ille effects of [cuxihle 1I11"rn," i\'\'~ nn \lJ1\llill~ time lIml COSI . For example, III Il1i, cnsc W~ could compare d('lay~ IJUd., I 1111: current ser vice rate of I wn pcr day wnh J '~rYlce rate of mree per d;.y 0, "C could unrnducc one or more addu ronal channels

Simulation and Computers

rile calc ulat IOns III Table I rI-4 nrc le(hnu\ In ;,11 actual a pplicat ion " l·UIUI""" r model w,mld he huilt ro perform the l\rilll~~I~ TII"rc ore now several ., I 111111 n! run pl,ckl1g", IIVHII"hlc fOI· personal COnlP'IICr\ Ihlll haw (he capability 01 hlilldlllg ve Y complex I 11 Oll d4 , ~UII g~n~r:ilc ranuoru vulues fl'l1lll [I wulc range of drsulhuuons. :111<1 'It'CllIlIlII'IiC ~Il!I i~IIC~ and summary mCIlHLII{'~ (If lll~ rcsu lts." Mnny even 11II~~ ,I Wuplll~1I1 IJ'CI rmcrface and ammanou, ~lll)wlIIg Ih~ user 'II") observe the ',I rnul.umn as II ne,'11I ~

II IS al,o possible 10 build rclnnvely ~llIIpl,' models of ,y."em5 on ~prcmlshccl~ Appendix 2 of itus chapter is a TlI[OfI~1 10 hu,llhnS such systems. And for fisk anal ysis or Monte Carlo models, such a~ rhnr Hlusrreied in Example 3 below, spu-ad,heel R III'~ qu ue cff.cc I ive and c. n h a nd le even q U II ~ complex models Til ere nrc popuhu sufi Will ~ add-ins to spreadsheets IMI mnke Ihis even easier.'

Computer« of course, make ;1 quill! ~:r~y In r,"l1erale many simulated pcrrous ur I rlilis -not )lI\l the 50 Or $0 used In the manual examples in this chapter A IlIrf,!: number or mat. IS cssenual in ordet tn nbt.un valid results when simulanng sy~I""" rluu in vol ve n1 ncl 0 III ness. cspcci n II Y gll~tl1l1!1111 "I W!l1lll1g Ii [lC systems

ltowcver. II IS instructive Ln go I 111'1111 [1 h llie I11nl1L11i1 examples M IIII~ chnplc III order In undcrsrnnd I he bas ic ideas ill vul vnd h XiII II plC.1 2. n lid ) below COIl'1 i'11l1e I hi~ pnuern

~Fol ~L rcceru ~ur'l,lc.'y of simulation Sol.lrtwnl~' Set" JLllllt·~ I 'iw.un. "Srmulation Su rvcj ·~"tol ... rrH' Proceiv Ulld'l:iII"UifH..!mg and I morovemera." (JRN~/S. ltJdrj)' t\"~LI~' I Q9S

's,~", rm ex.unple. I he program, @RISK (Ncwueld. NJ, l'al'SJ.dc Corp., 1994) 'rid Cry,',,1 Ilull (Houldcr. ("0, U"",oneof1ng, lne.. (9941

41(,

Pm'J In Applicalion tVtUH

ontrol

Simulation and Inventory

TAIJLE 10-5 Probnbltlty

D isjri button for Weekly Demand

TAlILt IO-fl Prohabilily Distributiun for Delivery La~

The use of sirnularinn is not restricted '0 queuing processes, Many phases f hllsil1e~s opcrarlons have been sirnulured wilh successful results, We shall illustrate by a brief example how sirnularicn could be applieo 10 the solution of an inventory problem,

Example 2

5 u ppose III ~l I he week I y derna nd of a ceriai n produc I has I he d iSI rihut inn shown in Table 10-5.

When an order is placed 10 replenish inventory, there is a delivery lag. which is a random variable, as shown in Table 10-6,

We warn 10 determine an order quaruity, Q, and an order point, R. We can do this by trying several values of Q and R, and simulating to determine tile hest value"

An illustration with Q ~ 15 and 8 =- 5 is shown in Table 10-7, Note that the opening inventory is set to 10, and live weeks arc used for InitinJizmion before the results are counted. We assume no backorders arc allowed, If we established the CO~I 01' orderi "g, the cosi of holdi ng in vern ory, II nel the cost of bei ng ou t of 510ck, we could estimate the COSI of the inventory system under the rule Q "" 15 and R = 5. Ahernative rules could be compared to this, For example, formulas for optimal order quantity and optimum reorder point could be used, even 'hough the assumptions needed for such formulas arc nOI met in our example (the replenishment lead time is no' constant), The "1110U11l of error introduced by using Ihe formulas may be esrimmed by 'he simulation. Frequently. a method M solution may be operat iorially useful even when it is nOI srricrty applicable theoretically,

N,jIJIO(:f' fJt'lfI.J1llded

Random N~mbt.'I',f A ssigned

Probnbrli/~'

o

0.10 040 OJO 020 1.00

001009 10 10 ~9 501079 so to 99

Number n/

H',,'i.'kJ" /tnm Rwulo"f

Order to Numbers

_/_.l_' I_i'_'"_;f >_. /_·,'o_I_>n_"_d_",_" A_'_,f': XJ1cd

11.20 0,('0 020 1.00

001[] 19 2D 10 79 801099

-_.j'

.,~

1 ',II

'01

;','

.. ,

417

TABI.!' 10-7 f"VCIIIMy Shnulutlon Illlls'rfllioll

Wl'!d~ NitlJl/n!J

6 1 R 9 10 II 12 IJ 14 'S 16 17 1 a 19 20 2 I 22 23 24 25 26 27 2& 2~ 30 31 32 33 3~ 35 36 31 .i8 )9 40

'Jt'gjjIIriIl,~

Recctpu JIn't'JHor1'

o

I;

10 9

!\'UfJdOljj NrjJll}J('I" (If
LOJI NIWlhf:t' W,'d.·,r He I 1('('
U:rJlldOJrr SnieJ EllrJrrl,t:' S(II~'.~ [ar WJw,j Offlen
NHmfJt>t' (Irmt.t1 IJrL'(;'rrror'_I' (()jjw~e.'i} Onters Orders witt Arrive
-------~
}7
.11
68 '5 4_';
8.1
% o
II 1'1
91 II
99 a
57 6
2$ 5 1\ 1\1
70 J
}]
91 14
('7 12
97 9
61 7
II 6
50 IS Rli
25
nli (I
M
SO I J
19 12
RR 9
25 R
2~ J
6R 15 .17
78
37 1
0<1 0 IJ
32 16
75 ,~
21 1 J
4, '2
40 II
71 Q
as 6
8R ] 15 15
N 1
G I 15
19 '4
~o II
2'1 10
16 9
J2 ~
n "
0 I)

15

15

15

15 14 II ~ (,

5 3 Ii III 12 9

16 1.1 12

17 17 16 14 IJ 12 II 9 (}

.1 17 15 1'1 II 10

~ 12 103

Sununury

1'1 ohahilistic sirnuluuon 1111"IL·ls include rundorn Vaflllhll".' lur uurer tniu cvcrns. Rundorn num hers a rc a" I !~l1cd In a<.TDI dunce with I he prohnbrlurcs rOI I he uncertai n events, and the \II"nlC C "do I''''CC~5 IS used 10 generale a hl~HU y of event' for srmul a ling the system under ,I lilly Qucu ing and rnveruory sY'("II1' nrc examples of probabif ~ I ic si m III Sf ion apph C ~II 'H' \

Risk Analysis

Consider the dcci sron on a major capual invesuncru such dS the im roducuon of a new product The P' cluatnl ny or I he Investment depends on ,eVel "I (ne lnr\ lhat are guuerally unceruun h\i'l1aIC~ (II rotnl market for the, prndlIC\, the mllrkc! shure thai the Ii r m can au ~ ill: I he gmw 111 III I he rna r kct : I he ellS! or 11r0l1i IC i 111\ the product: the se II i ng price: me Ii lc 01 111\' ]11'1 Hille r. and even I he co> I or II III cqll i pmcnrncedcd-« all are generally suhjccr i[1 ~lIb\I"1I1 ial uncertainty

One common IlpplOiICl1 would be 10 make singlc-uurnhcr "best esumates" for each or the UI1CI'.r1alll II,ctms .rhovc and (hen 10 calculate ;I u IC~MJrC ur profitahility. r his approach has 1",0 drawhnckx

I, There i., 110 !'\W" I ill I[Ce tha: U~I ng the "best CSII rnnres" will f:i ve (he true expected pro Iii nh i III Y of IIr~ proJcc I,

2, There is no w~y In 1\1l";1~111 ~ the rrsk associated wuh rhe mvesuneru In

pari iculnr, tile 11M 11 "Il~r Ira, no way of deter min,">: Ihl' prohahillty Ih~l the project Will lose lIIoney or tile probability lhal VCI y hnge profll~ will result. For exam pic, ll~1 nr. only the one - number approach. It 1l1111ll1!ler would not be able \0 <II SII 111.\<1 i~11 I lei ween the l WC) projecrs show 11 ill I, iglliC I () I, And' yet s uch in FCII' rnunon i:; IlceC~SIII y i r ICC], n iq ucs for Cklllilin willi II sk. such as

01 ility Ill~~~m~." lire [0 he npplicd:

Risk amdysis i.1 a Ic~llIliqU\' designed 10 circumvent IIl<.·~l' two disudvamages.

The ge"",al approach " rn i,,~il!n a subjective prohahiluy d i~1 nbnuon 10 each un·

l'(G Uf(!': 10-1 Corn partson ·111' l'wn l'ro.j\-l'1s

/ P'ojoCIS

o

"S. ,I OSI,mal e· ror botn

P,ohrabllily

.,\ '.

,

' •.

k nnw II rnc 1"1 alld [(1 cnmbi ne I h esc, 1I~ 1111-\ IIII' M"I11~ (';II' 10 ~I m ula I ion .r pl'rn~t h. 1I1[\.J [I 1"llh:rhilrly 111.111 ihution for rhc prf1.1ccl jll'OI,lllhrl,ly ns a whole, TII\~ l·"ll 111" ~11I1WII will\ II ~ilI1JlIc example,

I'~,umllk 1

SIII'I'''''' we ,lie cnusrdcnng mar kcuug ;, new I'ruduc( The investment rcquu erl " 'j.~ 1111110."" 'I'herc "'e three uncertain rn(I<lI' ,,·111111,' pi ice, variable cosr. and (1111111,,1 ,n I~, ",,1,11'\'· The )1ll'duct has ~ II Fe of only one yeill I uble 111-8 can I,ll n \ I he: 'a 11("111 e; r'''~ihle lev"l, "f these rae",,-s, Ingclilel with II,e cs: irnated probability of each W,· will 1I,~IIIlIC lIull I he faclors in Table I OH nrc ,lilli" lcalty indepen d", 'I. (Till' IS noll II1IP"I"I~11I "I~lIlIll'l iOI1, I r it were nOI true, we vmulli Wont In modify alii si ruuhu iUIl In me lude '" haievcr pmr.abil is! ic dcpcndr-nre we kit ;J PP' opri arc.)

Ikc;HI"· 1111' i. J 'cry si rnple example, II I~ pnssihle 10 use deci slOn IIl.'C olild 1'1,)]1,,1",,111 Y I rce tech n Ique~ 10 en lculare the vn rmll~ outcomes and prol1all!i II Ie" In Illi~ UI~C. 11',' 11II\'C oilly "\ . 3 . J - 27 1'0~~lhle d"IIIICI outcomes, However, III ;' 1111\r<' "~III'~II~ 1'1<1101<'111 wllh rnnny uncermin r:IC"'f~ eucl: IlIIviJig 10 Of 2() levels. we <''1,,1,' cillily IHIVI' 11 milhon possible "UI~(lIIl(·S III 111<:~L· cucnrustanees. rhc rech 111'111(' 01 'Illlllljjll"ll <'ill I he very useful ill csrunoung I1nlll (he Ilvcmgc profnabilny u! ihu II' vcxtrncnt ,linl II, "nvkrnexs" a.~ dc~<;rihl,d h~ rhc prnbabrluy of achievmg V!lm"'~ levels nf prnht

We hr~1 need a "'Jy of ge nerau ng rundorn ~!lllOC~ lor I he elements of Tahl., I O-~ nccnuling \0 the stared probabiluies. 1\, IWI"[lIC, we associate vo.IIOUS rnndnm numbers wuh vilrious outcomes. as in Tallie I (J 9.

N(IW W~ C:I n heg i n I he si mulation We gCI1~ rate sing le -d i gi [ random II U III hL·r~ I rrun rhe I :111(10111 nil III her \ ab Ie (Tnble 10 2) nnd , 111 turn, dClermi nc a prl~c • .I rost , .1 nd a vulumc Once these elements how been deter nuneu. prnfu (i n mrllinn ~ 01 ""I, 1;[,,) " C< unputed ,", follows.

I'l"oli[ = (Price C(J~I) 'VUI~IHW ~,()

'lhcu I.II~ JlI'\l~C,~ i, repcutcrl a lnrgc 1I11111h~1" orl il11l:.\ 10 ucneratc a large number <Ir I"nnl ourco.ncs S~~ Table 10-10 Ior 11 suruplc of 25 tri.rls, Nme Ihlll III I he nsk nt' aly'ls I).'flt· IIf ,i In U IHI ion, each Ina I is scp.u ,1W f 11>111 I he rC.II: thus. there IS Ion IIl'(·d rur any 10111;1 II (,1\ IOn pcnod.

TAfll-E 10-8
Factors in Risk Sri/jill: \.0rIQh1p Slll('~' Vnlllll1(
rlrrl" "ll"'rlmhl"II~' Con PrnhnblJ.I\' (HrJUr(jJr Hlli1.S J (lr'f'bnJ"lul'
1\ nalys is ,I'.:xa mple
\4 ()J S2 01 .1.0 0,
~ 0\ J 06 4.0 OA
(, 112 o I S.O 04 'I".\lli,,- 10-9
H:lUiJom lumber ,~,.fJw,~ I(llIulrml 10rmb/l' ~1I~rfl(Jul l"~'cs ',*,huPit' HmrtimJ1'
l'rJCf' -VUjllll('t' C'~f' Nnlt~I""ft '~mllJj':uI.N.r'U'51 NlllIl/·'i·''f
1\ ~signl1rlents in
Ihsk ,\ nalys is ~~ 01 1 ~l 0 J n n.
r::xa ITI pic I I 7 .1 () -l.0
(, s. ~ 7 'I s.o ~ 'I 4l!1

N"lul~JIIJ RrrlJdtJor Nn.ul(JPII VnIUIJI(
lirol NJlm!lt'j 1lnff' NI~r'j'n.·r (./111 NJr".iJt'l (Indium rlIW,' J
- -- --
I ~ ~(, 0 P (, .\
, 0 .1 • 1 1 ~
J I h \ 3 \ 2 .1
.\ I • ~ I (I 1
j I I .1 (, I n J
6 I \ 6 1 ') 5
J I I L f1 1 7 .1
s \ \ 8 <I I, 5
9 ? 1 8 " ~ s
10 01 6 1 I )
II i \ J ,L 1 4
12 'I (, ~ ,I (, 5
I :I ,I \ 9 'L J 5
I~ I .1 2 1 (. \
1.1 'I (, l 1 J ~
16 0 I S \ 0 .1
17 I ,I I I K 5
1 R 11 • 6 1 " ,I
19 ~ 6 S 'L (, 5
20 9 s 2 .1 4 ~
21 () , 1 ,I 1 \
II 0 • 0 2 ~ s
n 4 ~ 0 2 I 1
1. I (, ~ s 1 s .I
!\ ,I ,\ 0 1 I J
AV(',"I I'IIIII! 11)., III R isk i\ nu ly.1 i~ E~lImI'II'- 25 Trllll,

I'WfH
($ ""IIJ~")
15
1
-2
I
,
0
n '"
I .~
I
0 )
0
-I
l '!iL' ?, ()K

lWCOly·I'IV(· Irial' i, 1101 enough tf) mukc II precise esrirnate of liI~ IIvcmue prntitabiliry or of the probubiluy disiribu: inu of 1'1 nli[~, [I' this process W~I'~ [lIlW'all'"lcd on a computer, u thousand or more trin[, ,'''II[d he easily simulated. l lowevcr, for illustrnti ve Jlu 'I")M:~, we wilt base OUT discussion un the rcsu II~ of these 2 ~ I nuts.

N01e lhnl I he average profit is $2 OR rnilhnn. II IS I ntercsti ng In compUTe 11m willi simpler IIlClhLKI\ or analysis. For example, II we hod used '[he one-number approach a nd used III~ 1110,1 li kel y value for each lncior, uur csti mute of" profu "'" LJ Irl have been

\1()~1 likely prufii = ($5 :b 1) . (4 ()) 55.0 = 53.0 rrulhnu

Thus, Illu si rn ple one- nu m bcr approach. ill I II" case. sign i fica mly ovcrsuucs the expected Pl'Olilllhllil y or I he i nvcstmcru,

f'lCCIII"t' iii, II Ki rn pic case, COl n [1111"1 ion III I he e xpccicd prof I (the prolll of euch 01 IIIC 2 7 possible nutcnrnes, weigh led hy I he probabihues) cun b~ pcrfnrmed;~ lhl; expected profit " $2.14 rrulhon, Thus, ,I' one would expect, our sample a"CII'~W for 25 urn 1\ " I" LI I""" I se 1 y eq ual 10 expected pwli I. However, the ex reeled prnfi I cul-

"ln .hlll C" .... ~{". ~1ncrlht: tacrors are Ind~pl:ndc:n! [1lla jclJ.,~d h)' ~~mplc. rnuluphcnunn .Llul addtunn. ..... e can cumpute the t,,~clcd 'Profit from the expected .... jJluc:~ of price. C05(. and volume: I( twlWC'io'ct. these Cit rot: n'~ were [1 LH 11m:,] rly rela led or I nde rcndC'nI ~ he n 1 he complete set (If b{ J.flchc"I ol I h t pmb.h,l,ty Ire, "0111,1 hnve If) be evaluated

,I

,j

'I

_"

:!

"

h(;1I1H. 10-2 I(isk l'rofllc:

Surnple

l 'urnulat tve Pn,hahili!y I'unclion

Summary

\ 0

OJ

F,j ,9

~ 15 u

~

5.

~ fjf-------

i

g

J,

~I-_~_ ot=--_

-s

o

5

1"0111 is mIU",n'l

10

culaunn sheds 00 light On the r/<k ,I,,,xialcd with the inve~lmerH. whereas the SCl of 25 s.unple outcomes clearly rrulicrncs Ihal one may nctually IIICllr " loss (for exampic, trial 2 In T~ble 10-1(1)

A convenient way 10 rC~rC~t'lll rhe I csulis of" risk il\lil[y~i~ i, In ii:llilic OUICOI'l,e~ hy pru!ilahilily and plol n !"I"1'1i (Ii' the sample curnulnuvc p",hahilIlY lunction (Ice I'IIII.II<! 10 2). This IS called " r /"k """jilr From Figure 10 2 'We sec that there i~ a ()!\ percent chance of making () ~rnfil l)f more (and a 32 pl'rcelll chnnce of iocurrmg II Imi.I): 1111:1 c IS a 36 percent chnnce nf making $5 rnilhon or mOIC, untl 110 chance of IIlllking more than $15 million. 11K 1"1'1l~[' numbers or trlals lire ,iIlLUIIlLCd. the curve Ill' l'iUllI1: 10 2 would smontf nUl scmcwhut (although il wnult] cuntinue 10 have Ihe SI:UrCIl'C shape because ihere I' a finue nLJ rnber of a ltcrnati ve OlllCOIHCS rat her Ilmil an mfnnte number).

I{ I \~ lUi'll lysrs i.~ an applictnion ot vnnulauon 10 evaluauon of rnvesrmeu t projects. l'rohahilily distriburions arc JI~,C~~c!! fill rhe uncertain f"Clnr~ iuvol ved in ~ projeci IIIltI ['II II I IIi ned, 1.1 si og the MIlIlI e Cmlo PI"OCC,IS, to obi II i n \h~ jlf\,lHiI!.i lily d i 51 ri \JUlian I or O"CrJi II project profitauil il y

SImulation wi til Conti IlUOUS Proba hi lily Dis tri bu tions

III the risk analysis exurnplc ,II love, III<' random variables WCIC discrete (e.g., selllnp, puce look on only three d"WlC'1 po,,,hle values: $4, ,.~, ,,,,,I $6) There may be ~IllMI IUI1~ In which we would like 10 assume that elemenrs arc ra nrlom variables druwn trorn some conrinuous prob.rhiluy distribution, SlLPPO.IC. for example. (hal we

rell 111m lml111~1 ~nl~~ VOlllllle III Ih~ Iisk SlIIf,IY,<lS example wmll<l 1)(' !HII 1"lLlly d,,, libutcd. wi III mCf111 /J, 1 n 111111 iOL' , II I i I.~ ,,,,(1 ,I" nd nul LI~v i '" iWI r!' n, ~ nI, II ion LII1I1~, How ca n we gcncnuc l'IIiH 111111 I', d'IL"1 of ~;ll ~~ volu rnc I'm lISl' III iI "'I'" 1;1111111"

One way 10 sencr.ue landOnl va. Illhle' ftom cnnrinuous dlSlrIllIIllIlII' I, III plot the ell m u I at', ve di str] iJL"I<l11 111111111111. 1;01' the nor m a I d .str] tlLlllt1n III~I 111~,1 "I nned: 1 he cumulative dl~;[,.ihulinn l'lIlICIIIIIl I, ,IIOWI1 in Figure 10-3,

III order In usc II,e 1'L1I1",IIII I ve drsmbuiion ["nelioll, we lil'~1 11,(' [I tuhle of random numbers (like Table 10 21111 ",'"craie 3 random deCllI1al h"lwI'L',,1I "I)(I I. This can he done by !akln!! I h rce Iluullllll nurnher s from Table I (I 2 'lml 1'1,1<:11')'\ the decI mal POIOI in r rom 01 I luru I -or exam ric. I f I he fa ndnm uumbe I, 7, , and (, were tI,.,IWI1, ihc co,.r~~rnlld",),: d"tllll,,1 w"Lll.d he O,73~,

Then I h ~ ~"1111 rlnt i vc nil 1'[' "I h !llli ~ IO-J i S '!lPI~,.eil 1m /11/' 1'1 ""1'01 " ,r,1 III 111 C cm rcspnnd i ng tlcr 1111,' I I'll III~ (1l,7 II, 111 ('U r CXJ 111[11. u). I.) ,'1 w II hi" i /,( In ,:d 'I n~ over 10 the (\1 rnu I at i ve c ur vc. anti whc II 111\- Ii 11<: ,11 h eigh I O. 7 ~(, 1.1I1~llll' CIII VI', drop ~tra ight down 10 the hOr"OI1'lal "~,, I hen I cad off I he value reached. I h" v,11 lie Will be the parucular random value Lic'll't'" 111 OUI case. ilus value is JpPI<l\llIlollt'lv 3 30,

Tb is mel hod of gencr.u m~ randnm va lu cs works hecnuse I he chouc of n r~ ndorn decimal between D alld I I~ equrvalcru io choosing a ranrl.ol1ll"'I'I'I'""II' Ill. The drsf ribUI ion, Then [he tlgure IS l,,~d ,,, couvert I hem ndom p~r~~111 de (,,1 U L'" case, the 73.1> percent ile) 1{1 .1 par nculnr 1,,,I\1t' (3 3(]). The rnerhnd il ACl1rrill und can be used for tlrty cumulauve plohal>il."y divuibiuion , either conunuous or d"~lelC,

For a normal random V~lli<hlc ,Ih~ process JUS( dcscn bed C'I11 he performed usmg standard nnrmnl ("blr~ (see '1 able A ill the end of (he lell) We C Iller (he table with the random dcci III" I n /1(, .lntl Ii lit! the correspond I ng L ",I lilt 1\ 7. n, 61. Then II.IC random estirruuc or Sllll~' vuluuu, "

Sales volume I' I I.rr 'j,O I 0,63(0,5) = l'\ 15 mi lllnu uuits

Fir.tIRf. IO-J Curnulatlve Normu! Dlstrlhutlou

(t'- '" ,HI, If II.';)

,o~-------------------- ---------------

; 0736~ ~

'" o

g: 0,5 - - _.. •• • •

--L _ ___j~/_-'- a ao

30 40 511

o

10

2.0

Million unils

,. ,

~:

,~L!rllell mcs II is pm", i b Ie 10 pcrfor III I he IIIH1vC pr «cuss n lgch r aicall y Sec Appell rtl x I. I 0 1I11~ chnprcr lor a n ill ~LSIl'n I len or 1I1~ 1I1'~l~ I."'I'IIIC method,

Computer Genera/if/u()i Randtnu Vnriuhles

Sprendsheet programs have the capability of ):cnCrilllllJ' random values from vanous prubnbrhty dl'lribu(illns. For example, I':x~cl. cnn SCI1~rillc random draw; r, <1111 til!' nnr rnul, binomial. cxponeruial. Poisson aud (lIi1el distributions. It also has ~ function RAN 1)( l, which generates a uni form random value between zero .111(1 I. Some or Ii.1C.'C ,ll'r illuvu nrcd ill rhe tutorial in Apt1r;n(li~ 2

Summary

Sillllllllli<", 111")1 be performed willi coni inuous 11111110111 variables either hy graphic, I ~hlllill look -up, 01 cnrnputcr genernuon IJ" Ill!. I he 111'1 irnpnate cu mulatl ve probnbi:

II}' drvtr ihnuon

Simulation or ornplcx Systems

A II hOlJgh 'IIIIU 1;11 iOI1 is a usef ul IIlnl I n {jell II n,'. Wl\ h que UlIlg, 111 veruory, nsk ;111111 y~", ~od other I'rnblcm~, perhaps us grcnlc<1 ,,,"(,,1>1'111"" i, In the analy~1< of complex ~"'SIl'Ill' Many real-world problems In\'I>)'',' 'y,It'Il" made up nf many component pml, 111.11 ,II ~ I II tcr rc I atcd: the system mny be dynnnuc and changing over I 11111", nntl (lie sy~lelll 1IIIIy involve prububilistic or uuccumn evems. Simulation may be urc only techmquc f,)I' Ci. LI" III itativc analysis of such IIrobll'll1o,

Wc sllllii. 1I.'~ u n example [0 illu SI rnte [he LI~e 01' ~ i IT1U Ill! ion for such prohlemx Consider the operations of a barge line tlnwlI the 01110 Mississippi nvcr ~y'>lCm,1 This harge ~ompany I~ a subsidiary or n stee I t'nlllp"ny and receive, barge loads of .,(cel III 1(' 1i(1IllC pori in Pi nsbu rgh for ~hlpmr nt dnwn (he rI vcr 10 va rrnux por I', ,lI1d 10 Gulf ('(HIS! pons by another barge linc Flr,urc 10-4 sketches the operutiuns "I. Ihis S.,.~I~III i'lJl'gc loads of steel arrive 1]\ (lie i'III.,hurgh pon in a random fn~hinn rcprcsc mcd hy n proba bil il Y d istri hut ion in I:i All I'~ I () .4, The desti nat ions of these bM~CI :11~o v~ry from lime 10 lime, shown hy iI,~ hcquency distribruinn 11'\ the r,!;II re If" hln ge l~ available. (he steel i s Joaded Otherwise, il m lISI be sh I ppcd Ily aneiber (IC , (I lorcrg n) barge com pliny. A Ul~ Will "~rl with a tOW of f u11 bu rgcs (lOW ,iI<' II hnutcd because or (he lods In tll~ river -ystcrn) and calls MIll" vn"mll ror'l~ downstream. The number of pnll' il simpli lieel to SIX in the il I. LlSI ra II CII1 , AI ('~CI.I 1'01'1, burgcs designated for thnt por t iii'," (1.1'(1I'I.l~d, 1\1 N~.w Orleans. 1)1I1"!l~' tlcslill~d f"l Ciul.f I."H'I~ of Pascagoula (1') 1<ml [),lIl1gC (0) lire trunsfcrruc ,,, uuruhcr b~rgc line and 1.I,ell the lug turns up.<lream und prcks LIp avallable emply bl" gcs j 1'(1111 (he POI(S"~ II goo" These empty barge .. .rre av.uliLhlc "rter a rurnaround t unc (for unioaliing I, winch IS 3 random event nne k m I he home port. (he lug rCIU 11l~ 1<1 Ihe

'1'h" .'OILlpl, "os "d'plcd from G. G, 0' ~ric" ,,,,,1 I( II l'r,llIe, "The Schouul,,,£ of" n",~o [.1<,,'," Ii,,,,,,,,,,'l\ /;:''''''0/' 7 11959l, pp, % I 70

424

FIGURE 10-4 Operations of 1l31'gC Cornpany

A rri vais 01 su~el a I port

'I "'"-J.~

Ncrnbar (If

barge loads dady

C I. E

t

M N P 0 o

Oueue 01 available tuqs

Po I icy rules;

Scheduling Tow size Destination Ole,

Queue 01 lull barges

Tug leaves willllOW

~ 4 days ""':----------------------------------------------------~

Cine 1M3 I i tc I

I~--D-ro-p----'~

~ b;lrQBs

I day t_______. '--,---;

j

Frequency

Tug returns 10 a"ail~ble lug queuo: ~~rge:; rOlclrn 10 amply b.rge quoua

Pick UI> barqes if space in low

1

Loui.ville ILl ,

,

r

Evansv,llo IE)

! n _ 0"'""'

/ "" ~~~-+- .,___e_m_PI_Y_ba_,_ge_.__,

Tumaround time

Slaps "S above lor "II POriS

y

Mompn,s 1M) ,

,

y

New Orleans (NO) --------------------------------------------------------~

.~

".; ~ -

.}

··',.l

·oi

."

avnilablc lug q(ICItC (uficr Hiking a short time for restocking, repairs. etc, I and the barges go \0 I II~ empty barge l)lIC(IC, boih ready 1O move back into I he sYSlcm ngain, The company h~", ~ ILlg~ ~11~ 127 barges, and ill :my one lime these rl1;l)' be scattered throughout the system

A si I1llJ I auon model of th is 5Y$1 ern has been constructed and progl·o mrne d on " computer. The probabilistic elements (ar rivals of steel, destinations for barges. and I u rnaround times) 8 re i ncorporaied US i ng 111 e Monte en rio si mu la I ion tech n i que. The cornpu ter mode I m USI also keep track of ti me in the system: keep {rack ofthe barges. tugs. and physical limitations in the system; move the tugs and barge" from pori 10. port in accordance with travel distances (four days from Pittsburgh to Cincinnati. for exarnpl e): and so On,

Once such a simulation model is developed, nlansgemcnl can use il 10 try Olll poss i b le iLl ter 11 at i vc pol icics, Several schcdu ling ru lcs III i gill be I ri ed. inc ludi flg:

I, Having a lug leave Piusburgh HI Axed imcrval.~-8 or 10 days ilpnrlrega rdlcss of how rna ny ba rgcs ; I h as.

2, Hu vi ng a tug len ve when il 11 as ~ lOW of ~I least so rna oy burges--16. for example.

o t her schcd LI ling pol icies arc, of co urse, pos~ i b lc. I n add i (;('\11. I he corn pany could examine the effects on the system of additional equiprneru-c-rnore barges nr tugs, or f aster tugs,

The si Il1U lat ion model a I lows 1 he company 10 ex peri rnent wi th these and ot her changes wi thou t ha vi ng If) try I hem riu 1 on I he rea I sys [em, Beside, the ens l of disru pi ion 11l~1 WOu I d be i ncu fred, il is di fficu II 10 cvalu ale res u I IS of a n cxpcri meru in rhc real world because other external factors arc constantly changing. II ls hard 10 know if rhc obser ved resu lis arc a II ributab lc 10 I he eX!!)1 nal f~etors or 10 the c ha ng"~ i 11 I he ,y~wm, T hi, problcrn docs no, ex iSI ins i I11U I Q I ion models because I he ex Icr"al rneIO!"!; can be control led.

Simulation has been userl extensively to deal with a great variety or problems.

Simulation models have been built for transportation systems, (acrorics .• ind airport operations: lor the processing of defendants in court systems; for ambulance and lire services: for computer and communications systems: and for studying urban and world popular ion and econo rn i c growth.

Although sirnulauon models of complex systems call be very valuable, there are some disadvantages. They tend to be relatively cosily 10 build. II may also be difficult 10 va I idate a corn plex s i rnulauon (i .e.. ensu re t hal I he dcsi red mode I f rarnc WOf k IS properly represented withoui <ony "bugs" in the computer pr<)grnm or logic). Also, one rnus I dererrn i ne an appropriate ill it i al i zat inn period and run length for the s irnU lat ion, S"II iSI i ca I mCI hods ca n he u sef u I i n dctcrrni ni ng 110W long a si rnu lat ion shnu lei he ru n i n order In deterrni ne whether a par I icula. resu I I i., due tn cha nee or i, a sysrcrnm ic result, And, 0 f COli rse, like al I models, sl mtllm i 0 ns arc si IT) 1'1 i F,calions of the real world and mill' I'ail to adequately rCPI'CSenl important elements or rclat i onsh i ps,

Summary

An important application of simulation is the xtudy or complex opera, iOI1 systems that ca n~OI be an a I yzcd by 0)11 i mi zat inn or other mat bema ica I methods.

426

,---- - ._------

ApPE I)IX I

ALGEBRAIC METHOD 'ro .ENl':RATC RA DOM VAnlAHLFS

Suppose the cumulative distribution function of interest can be expressed in closed form (i.e. ill U Formula as a function of x without any integration signs): then the graphical process con be replaced by an equivalent algebraic relai ionship. For example, consider the exponential probability rlensiiy function

/(tl=Ae-", O<I<OC

The cumulative drstriburion lunction of the exponential distribution is:

F(I) = I - p "

Nnw we set a hypothetical random dccrrnal (R,D,) cquat to the cumularivc distribution lunction and solve for I:

Since our random decimal is between 0 and 1,50 is I -- R.D.: thus, this quantity (I - R D) CRn be con sidered di rec II y as a random dec. mal. So we can de Ii ne:

e-M = R,D_

Takmg natural logarithms:

- ,\1 = IOI!.,,(R,D,)

or:

r = - (1/.I)log,{R,D,)

This cquaucn can be used directly to gellemtc values lrorn nn exponential distribution with parameter A. hr51. U random decimal (R,D.) is obtained from a random number table such as Table 10-2: then tile particular value ohtained is substituted into the right-hand side of tile equation and solved to produce. particular value for L The value obtained will be a random draw Irorn an exponential distribution with parurnerer A,

For example. if A = 5 and the random decimal were I<.D_ = OA75, then from tables of narurnl logarithms, log, (0.475) = -0,744: and 1 = -(1/5)(-0,744) = 0,.14RS, TIllS value would be a random draw rrorn an exponential disrriburion with parameter A = 5 (mean 11.1 '" liS),

ApPENOIX 2

MONTE CARLO SIMULATION ON SPREADSHEETS

Modem spreadsheet software is quite flexible. and it is possible 10 Lise a spreadsheet 10 build unci analyze simple sirnulauons. This appendix is designed to be a short tutorial for usrng Excel to build such models, The best way (0 use this tutorial is to

427

sil down ,\( a personal computer with Excel and work through the steps as instrucecd, The unoria] presumes rha: you know at l~aSI the basics or Excel spreadsheet usag ,

We shall work through tWO of (he examples in the chapter, so you should review them before beginning, In rhe warehouse example, a variable number of mil cars RI' I'i ve du ri ng I he night and arc u nl oaded d uri ng I he day, II lakes exact] y one- h~ If day 10 unload a rail car, so a maximum of IWO can be unloaded each day, The probability distribution for the number of arrivals is a discrete distribution and is given in Table 10-1 I, We shall simulate 500 days of operation,

Step I. To start the simulation. open an Excel workbook and enter [he headi ngs as shown in Figure 10-·5, Also enter the information Ior tile probability distribut ion of arrivals in columns H and I as indicated. Fill in all the numbers as shown. including a value of 2 ill cell 82, whrch is rhe unloading capacity of the dock.

Step 2, Fill in column A wilh the number for each day, To do this, type the number I ill cell A 7. If the cursor hAS moved from ccil A 7. m vc it back (here, Then click on the Edit item at the top or the spreadsheet. Theil click on the Pill item in the menu. Then c I ic k on Series in the side menu, The cl ialoguc box, as shown in Figure 10-·6, appear., , fill it in as shown.

TA(lI~E 10-11 Distri bu t ion of Rail Car Arrivals

Numbt!l" of Can" A I",-jI,! il1g (X)

PmhabilJl}' of X A rrrV(J'S

o

(},2,1 n,JO O,JO 0,10 O,OS 0,02

VIGl1RE 1()-5 Headings for Columns of Model and Probability Distribution

H

F!(;UH g 10-6 Dnta Fill Dinlogllc Box

S~l '. om

I i-'·;I'.~·l.IloI;'-~

i 1(" L·",.

'1 r: , .. , .. ,,~I.h,

I . r~ 1,1,:,,01'

I r: ','"" I

. ,---""' '

I" lr~nd

T~.'Pe--···r. ~inear r ~Iowth (~ Qat"

(' A'.llo[ill

Selle.:. II'

, I" Flow!.

I (;' r&,~~~~~.n;',!' ~

01',

s \QP V"lu e: 1500

In pUI'I icular, chck on the circle next W COh"I'"S ami on the circle beside LiIlC{II', Make the step value I and enter 500 in the stop value. Then click OK, The column [rom A 7 down should 1111 with I he numbers I to 500,

, Generating Random Vallics from Probability Distributions

Excel has a buill-in feature lhul makes generaling random values from prcbabiliry distributions relatively easy. Samples can be randomly drawn from certain coruinuous probability distnbuuons (the normal distribut ion and the uniform distribution) and from the binnmial and Poisson discrete distributions. A relaico feature IS 10 allow random draws I'rolll 8 discrete distrihlilion defined by a table such us Table 10-11 and incorporated in COILlIllIl~ 1,1 and I In the spreadsheet created ill step I.

Step 3. Click 011 the Tool" menu ircrn ill 1 he top (If tile sJ1rcad~IICCI. A dropdown menu will appear end an item near the bouorn will be Darn 11I1a/ysi.\', CI ick 011 Ihis, (Nnw: I r the IJQ(a Analysis item docs not appear on the Tools menu, i1 may nOI have been added into 111e spreadsheet. Go 10 the Hetp menu and look under "add-ins" 10 sec how 10 include this in your spreadsheei.)

Slep 4. The menu shown in Figure 10-7 should appeal'. Click on the item Random Number Generation, (You may need [0 scroll down A Few iterns.)

Step 5, The dialogue bOK shown as Figure IO-R should appear. Fill it in as shown, The explanations [or the various items are as follows:

Number of Variables i~ I since we wish 10 generale only One column (If random draws from the probability disuiburion.

Nlllllbcr of Random Numbers is SOO-we arc going 10 lake a sample of .'iOO draws Irorn I he probability disuihu: inn.

The distribution 10 he used is a discrete distrlhulion, as defined, Clicking 011 the down arrow shows what other opuons arc available.

The Vallie and Probability I npui Range is 1--16 10 II I. II contains two columns, the ri rSI with I he val ues of t he random va rin hie and I he second wi th 111 e probabilities The probabilities must add LO 1,0, You can type In the values as H6:fll (Excel will Acid the $s) [}I highfigh: the cells on the spreadsheet

-,'

I,

i

FtGUtu, 1()-7 Menu

FIGURE 10-8 Dialoglle Box

419

Data Anal,psis EI

OK

Correlelion

COY(lliorlco Oescnotive 51all sties Exponential Smoothino

F· J est Two-Sernple 10; Vanance, F DUlle I AnalySIS

Hislogram

l~ illitllilhii1i!l6Jltll!tilliSilNM,

Rank and Percentile

Cancel

J

Help

Numbe! 01 Y_aliables:

Random Number Generation ' lEI

OK

Numbe! 01 Random Numll.ers:

Isoo

Q_i,jr ibulion:

rpO.omelers

Value and Pfob<lbilily [nDul Rang~:

ItH$6:$I$11

B. ~ndom Seed:

Output op~at1!-------------~ r. QulDUI Range:

c N ~w worksheet Ely: r N~w ~orkb"ok

Cancel

No ra ndom seed i, needed,

Click the circle next l() 01<IPW Range, and enter [he value 07. Tltis is the lOP cell in tile column in which ihc SO() random sample of values will be placed, When YOll have finished, click OK.

At this point. Column B on the spreadsheet (from cell B7 down to 8506) will be filled with va Illes for n IJ m ber of rail ca rs a rri ving each cveni Ilg. d ra wri w i til I he; probabil iues r rom the [able in til c spreadsheet.

430

SH'[I (" Movc In cell ('7 :111.1 IYI'~ ",H7+E(' TI,,~ II"II(;:LI<'" 111111 ihe nurnher of cars IL1 he lInioilile,d I11L Ii l!I I'l'I I !IlLy IS rhc 11 Ll 111 1"'1' ([day"11 111or1l Ilw previous dny IJIIL:; I he ar ri va Is I hUI III !'.III

·1

SlCp 7. Mo"c 10 cell 117 01".1 Iype =~lin(!'1I$2,C7) T'lu« ""he,llc, Ih;1I rue nurnhet or cars unloaded nn a III ""11 01.1) ,s the smaller 01 the dod ~ CJpilC II)' (concamed Ln the cell 82) or rhe IlILIII hCI nvarlable In he unloudcu. Till' I' '101 immediately obvious. 50 think about wilY Ihi~ ,I <0 A lso note rhe absolute reference 10 cell B2 using uie S. This i~ hccuusc we wan: I he refere nee 10 ,'I u Y ~ x~d wl ien we copy, as we shall do shortly.

Swp 1/. Move to cell I' 't and I ypc = C7 -1l7 The ""l)llw, nf C,II, tiel aycd to [he following day equals IIII' number 1(1 he unlondcrl leI, thnse actunlly LI[1ln,l<ipd

Y.,\L ,110l11c1 pnuxc "111m IH1I111 I" survey whal yOLO II,L",' 11"llt' (:It';llcd the lir~( tI"y III our model rk "lilT yOLL 111IdeL '11111<1 LI, We ILL'(' nnw ~llIllg III ('''I'Y III~ ~rSI day model 5[JO lime.' in 1>1 LI"I III ~ill,.,IIII'· 500 days' tll'~,L ILlil""

.1

St.·{) 9. Copy cell- Ct, I h""'llh Eh 10 cell> C7 10 EjUf,. There I~ more \h~" one way 10 dn this. Use the w:ly you know. '" follow the ~(Cp\ he low

Highlight cells (:(, rlu IlILIl" 1';(' and ClICK on Ihe COl'I' «:011 ill the top or the spreadsheet.

H igll I igh [ cctls C7 through E5(1(,.

C lick on IlW 1'''-1 I,· icon ;II I he rop or I he sprcHU ,h~el

YOII have now cornplcn-i! I he ~11l'\Jlm on" model The C()IIII'''ny r concerned aboiu the number ul em" delayed hccausc iii, eosuy 10 him' ell r, W<ll nng, Ihc "" l'Ic~ L n colu 111 n h shnw 11\1\, Y"l' xhoulrl move lip ,I nil dow n I \I" I\L~:II I he results. liel1cl"o II y. there will \1\: [llldml" wi III I i II lc or no del n y, (1 nil I h~11 n (IllY willi 1\ or 5 IH'rivnl.,. so that the I1lLLOlhuL' ilclrlyuli builds up. with pcrlHljI~ I () III' IIIIlI C rlllll'Ouci cars IJcI~yed. The delays I11l1y In!;1 rill' a perin\! of several days, nnil 1I1~Ll wurk rlown to zero again. Tlus is ~x~clly how qucumg systems behave

Sllmrll(lr\'zi11ii tlu: Results

To he usef U I, we nced I" ,IL L 1IIllii ri zc : he rcsul ts, We shull ea 1l'LIIIII~ 111C S veragc n LI mher or ca rs del aycd "nil, le Il' r L" I lie I he ens I or rh is de I u y, FlL III ,('r, we ,111111 produce a disrnbution showlnf 11(]W nuen each number nf c~r~ was del~yc(l HUI 111"1

Slep / {/. Mov~ 10 eel' ~ (;! q ,I lid titS and !ypc In the head IOg~ n, shown m Figurc 10-9, Then ITI')v~ ll1 cell 1111 ;lml type =/\vcmgc( E7:1'.5()(,)

Thrs will give ynn III~ ilVCl'Ilge number of rail Cllr, rlclnyu\l per tilly I'm II,u 500 rluys simulated

Slcp ll, Move 10 cell II:' <lnll type = IO()*3('5~1' 14

rh,~ is the COSI or ! he delay at S lOOper day per rarl CJI' fur " ~hS d~)' year.

Slep [1. Fill In the cull, Ci II) rhrougl: G39 with the V>LILLU' "I () through 20. as shown in Figure I () 9, These arc 111C "bins" for loh,,)"\inp; ihe rnunbc: delayed each nay T hey arc used III SIC I' 14 he Inw

I

!

PII';VIII> 10-9 ~ 1 ~ L
l lendings for
Sumrunry
luformu lion 114
I
1S
.. 16
~ , 7
, B
1_'9
2°
21
22
23
24
2!J
26
27
["
~~ 1
J'
32
33
34
~5
J·G
~7
J8
39
4°1 F

G

H

J

I AYCrB!1!,.D1elay Annulil Cos1

A"orlln"l~ 7 I· 506) 100· 36~·11~

.-

2

1

I

-f-

__ 1-

3 4

5

I'

t-J

--~-r

'0

~

j

I

l

11

-~}i -~ .. --L

1~ 1 15

--,

IS

'i1('1' 1.7. We nrc IInW g",ng 10 r1el~rnlln( lh,' rh~t, rhuuon or cars delayed C lie k Oil I he 'laols ucm al the top of the ~pre<l(hlwCI, iI nd 1 hen clrck Oil I he DCI/O Afifl/V.II.I 11('111 <In the menu Nex!. chck on the ffr.HoWIIIII ucru 1111 the Data Analysi; menu,

.'1'/111' 1<1. Thcllistngrnm dialogue 1'I)X, liS ,1111Wll ill FLg\L1 C 10-10, will U!I'perlL, Fill il III ,,~sll<lIvll In pn rucu la r:

The J I1pUI Range rs E7: E506 -rhe col II 11111 101 the number or cars de I:.yed TIlt" Hill Runge is G J9:GJ9- these ,11(: thctabulauon bins {step 121.

Click on ibc circle nCKI to Outpu: Rall/W

l'hc Output Range IS H18~Ihc corner for 1I1C OUlpUI, Theil CI'CK 01<.

132

['Ir:liI!H 111-10

Hi.lollium 13

·11I~ ... 1

I lnr,ul A \',e

l)_111n"M~

I'JE P 'I.E i ~Il~, jlGl19 I Gi·::9

Oull,,,I(.ejlo":- . r. O"lp "I A,,, e

I r fl'll-1''''.li;olk,~·,~etEl~ t: f)',w VlOIkbook

I~HI'f(

r P.!lI~ICI ( oiled ho ,lo(Jr~ml r- L.Lr[rlLII~llve l:>erC~I1I~~a r );.h",1 Qulp,;1

AI Iii" pomt , the d".tl ibuuon r"r ihe 11111111"" 01 cars delayed will uppcar. Note lilat on nuny days there wcu: /r-ro or no dcIHy~t1 ,'III S, hili that 11"'1(', were lome days wuh S "I (, (>1 more dela)'s

C/JlIl1Rill~ tlu: Capacit»

The rI"IIII, obtamcd ilhuv" were based on the .",ulIlp!l!1n Ih~l the warehouse dock liAS 11m L,'pnCJlY to unlnud IWo uulrn,ul c"" P'" day, Suppose the ""II1P,II1), could odd new "'IUlplllcnl thai '1'0\1111 increase the 1I1t111n(iill)! capacuy to three eill'S per day. Th" ,hould reduce Ihe {Id"y' I el uS .ICC hOI' mucl: s"vlng would resuh

Step 15, Wrl te dow n the current CSIl mate 101 tile J verage nu rnber 01 cuis delayed pCI' duy (I~ cc1l1l4) and the unnual COSl (ccll 115)

Step If" Move 10 cell Ill, anti enter Ihe number 3 'Ole Ihill ne ... values are showu lor the average tidilY ;11111 the annual CII,( Imh!.!, substanunl rcducucns. To oluain 1I1C diolribulion 01 (kll'Y~, do the following:

SIP/I '7, Click on the Ibots Ilelll nt the top ot 11ll' \prcndsheci Tht'll click on Dat« 1\'1(11,1'.\'/,\, uud then 011 ttistogra,». A dialogue liox like Ih~1 of FigLII'e I () 10 should appenr II may even hal'\: reruincd the values entered ill step 14 I r so, click on OK. If not, enter the values the sutne as described III \tep 14 Then click OJ , You will gel 11 wanllng that you '1'111 overwrite existing linin, hut this IS expected, ,0 click OK.

Yilil run see how the sunuhuion model coulrl be nn aid in rnunngcmcnr decision maklllg T11t: hel1e~tl or In~r~n~ing the unJo~dlll!1. CllpllCily from IWO m thrce 1 ailroad cars Pl'l d3y have been csurnatcd fmm the model Thrv would he compared to the cost III IIlkllllg these faciliucs

!',;/rWlfr Cnrto Risk 1\ fln/y(i.\'

I~Xllt"lll" , in 111i, CIIil[tl"1 tlncrihcd a lirlll cnllSldct'l~g the 1IIIIIIdilCI inn of II new product wuh unccrt.umv abnur tnc rn.u kct vrze , pnce, and umt CO" III thiS WIC)fI,11 we ,11<111 expand th.u example. Firsl, we ShBI! assume th;ll the Jlllldlirl (('1 he iruro dllt'cd has a ilm!cycill litL' New products typically have a product 11ft, cycle 111 which vales increase and then dcclmc We shall r"'"lur Ilial there is unccr uunty about Ii, ,I yell! '111c~. but then ,.lle, II1nc3Se by 20 percent In the second yellr and (hen declme hy 50 percent in the tlunl YCllr Further, wr shall assume ihar the unccrtairuy about lil~1 year sales call h(: <i~~cliberl hy a normnl distriburion wiih mean of 2.0 million cases and standard dcvruuon of 0.6 million C.ISC' The COSI of producrng rhe product IS .llso uncertain, and we vhall assume Ihill "II~ unccrrauuy can he represented hy J 111111," 111 distrihution h<'II\'I'OI1 'li2,OO and $4 00 per unit: The uncertuuuy about .he [II lee lor I he product i\ uprcscrucd by II dl,CII'I!' distrlhutinn (IILI)'(' II, l:xlll11J1lc J) a~ ("tlnw,

.\r;tIJprg Pf'J(/' tdtlllnrj ~r ,,"'1}

O,J 0.5 02

WI' shall assume (hfl( there arc fixed COStS assoclfllCd with in[rn<iltdllr. rhe product of '!o3,O 1T1I1lion in the '1"1 Y,",I[ and $1.0 million fflr each of years 2 lind t Fiua tty, We sh.1I1 nssume that the firm has the ability In ahnndon the product Jfler (he fir~t year 11 II tl 1101 profituhle (II' which case there wOll!(1 be no n xed cost> [<II lnrer years). A, I 11j.\!-lC.SICcl , llli~ il II Ilill! ~ couiphcarcd mnticl lilllil illu"lr~lc(1 in lixample 3 I n tl1·~ chnprer : however. il 1\ 11111 qunc <;Imphficti compared 10 one Ih,11 ll1i)thl he used for ncw product uuroducunnanalysrs

SICf' I. Open a new ~flleatl<lleel and O;CI il III' ,,~ shown in Figure 10 II, The tor pall coruains values for the uncertain facwr~ unit sales. price, nnd UOIl cost. For I he moment, enter II", Ii xed va I ues as shown (we shall deo.! WII Ii random va lu e~ shortly). The main pari of the model -cells CR through FI2 contains equations. lind tilt explanauonc f(1I these are shown in the ngure. Take care ill checking that the model 15 correct )'1\11 lI11ght Iry drffercnt value, for pnce or COSI or sales and \CC lite result. In pui nculnr. be sure YOLI lIr1r1'~"Hlnd the profu equations for year, ~ Ill1ci 3 Tile model nsvu IltUS Ih:11 the firm cuu IlHlJCCI sales And rllllll,~ for years 2 and 3 bll,ctl on the yelLl I results, and llim, if pwlil IS forecast In he uegauve. II Will ;1 bandon I he produc I ,lIul It II vc zero prof I

1~lIlcr the VUhIC.I flit tlu: look-up tnhlc (rows 14 through 19) cxncrly ns shown.

Tllty will he explained ~lillrlly

• rep 2, We are now ready III enter the funcuons to generate [he mndOITI values for price, sales, and cost There are IWO ways rhix elm be done 011 sprcndsheets. The ~r~1 wny Involves gencrntlllll ;I q,t I1f eandorn draws ~11~ putting them in n column of t he spreadsheet. This approach was iltustrated m ihe previous model in this tutonal mod cling rmlroad ear arnvnt-,

434

FTGtJRI,If)-11 Spruadshcut ",ilh the New Prod"ct l nl rnrluutinn Morici

435

The second approach involves the random number generating Function RANI)(). This function returns a uniform random value bel ween 0 and 1.0. To try it out: move LO il blank cell in the spreadsheet-c-suy, cell G2-"nd type =RAND() TIlI.1 function is <1 "hot' function in the xcnsc 11181 II draws a \lCW random value each lime the spreadsheet is recalculated. -rh illustrate this. push the recalculate key (key (9) a few limes, noticing how the value changes. Then delete the function.

Step 3. Move to Cell 03 and type =2+2~RAND()

Recall that the probability di striburion for unit cost is assumed LO be uniform between $2,00 and $4,00. Since RAND( ) generates a random value between 0 and I, two time, [his (i.c., 2'RAND()) will generate II value between 0 and 2.0, and by adding 2 marc, we have a function rha: will generate the required uni lorrn distribution (rom $2.00 10 $4.00 for uuit cost:

Af'ter typing il in, push the F'J recalculate kcy II few rimes 10 sec the result.

" 'J

Stefl 4. M\we 10 cell D4 and type =NOHMtNV(IV\ D( ),2.0,0.6)

The NORM I NV function in Excel calculrues the inverse value for a normal probability distribution. Three arguments must be specified: tile cumulative normal probability, the mean of ihe normal distribution, and its standard deviation, The function RAND(), which generales values l'rorn 0 In 1,0, supplies the cumulative normal value, and the values 2,0 and 0.6 are the mean and standard deviation for the uncertainty about sales. This function, as specified, will generate random draws from the required normal distriburion. Pres, the F9 recalculate key n few time!' and note the result.

'J

StepS. Movctocell02ftncltype=VLOOK P(RA D(),BJIi;CI9,2)

This is the table look-up function in Excel. Cells B I (i:C 19 contain the table giving the cumulative probability dis+rihution ror our uncertain vanable lin i t price, The value 2 In the function specifics that the second column coruains the values of interest (the prices). The RA N D( ) function determines which row is selected. When the random value drawn is less [han 0.3, the first row is selected (and price of $4,00 returned by the function), If the random value is 0,) or more but less than 0,8. the second row of the table is selected and a price of' S5,00 is returned: if the random value is 0.8 or greater, (he third row is chosen and the price of $(i.00 is returned. As before, press the F9 recalculate key [0 sec the result.

Note: The three functions in steps 3, ~, and 5 are nOI usually used if) spreadsheet work, so you may be a little puzzled III how they work. Yeo can get more information by u si ng the Excel Hcl p fu nCI iOI1. In any case, note that [hey war k by generat i ng random draws from ihe three different probability distributions,

Each time the spreadsheet is recalculated. new values For each uncertain variable arc created. ~nd tl new value for I he prnfitahility of the new product introduction is calculutcd. Usc the recalculate 1'9 key a few times and note Ihe very differcru values for ihrec-ycar profuability thar result.'

But the result or a single trial is not usefu' by itself. We need 10 generate nnd record a large sample of trials-say, 1.000. We wilf do that now. We shall create two

aSince the profu occurs over three years. 11 should be discounted using the epproprierc discount rate This: was omi ned 10 keep ihc analysis simple.

~olllll1n~ of v"h,~, l'hc u ,i,1 1Il1111he, I ,01'" I 10 II~IO w,ll he In column 11. nurl rhc ,',;,1111 ~ 01' rhc Ilw" ~illll(1 I, i nl.< ""I I I", III ""II"" II I.

SIr'I,6. Move In cell liZ and t'.lLle, Iii, numbci I. 11" lill' (COIL ,or hns "","~d 1"'111 cell 112, uiovc i! buck 11i\,1~'.

SI/'II 7. Click [110 I he f;d'l 1 rein ru lilt' lOp of I he srrcad,llc~ r Then click on the Fill il~11I IL' the menu, Then click on Sl'I"i"llll II~e "de rucuu lhc <.Ililloglic hnx. a, shown 111 F'~lIrc 10-12, appc;Hs: fiJi II 111 '" ,howl1

III paruculav. chck on Column: ami, "" LIII{!m Make the step ""h,c I and cruei 1000 111 the SlOp value. Then click nlc The column 11''''11 112 down ,1\(111111 lill wilh li't' number I In lOon

I" ltll 111 the values fl" P' "hi 11" the 1.000 Hlal, \I,' ," C );",ng !I' "'C thr I xccl ilalH inhlc couu "',1101 hili in" Lin I illL" ,II" I {' !LvCI' wny.

St,'p lI. Move In re II II ~ nd lype -I' I· 2 1'11's refer ~ to lhe .;ell conlallllng the lOlal

,1, rcc- year prnfu ,

Step 9. H,gh hghl the whole a rea t mill cell HI through 11 001. That ", ..... e "a III 10 'C I eel 1 he whole of hOI h colu In 11, H ;111(1 I, inc I uding II,~ very lOp cells and the cells rn ruw 1001.

'I

SII'I' HI, Click on II." .1)(110 item ill Ih~ lI1p of the sprclIll,he~l, and 1I1C1l selcc: Table 1"10111 the drnpdown menu, A tli"I"gll~ box appcai s 1.1""'1: empty 1I1C llllx lIe.XI 10 Nil" "'1",1 Cell, I.nlci G to In the io,,~ "c~IIO Cn/ulIIlI Ili/JUI Cell. 1 hen clock 01<. CIOI""'II [ will IlOW lill Will, Lh~ rc~,dls 01 1,000' "",Is 01" rhe .IH11ula1iOIl

Ord i naril y 111" IIalli tab lc cuuuunrul will subst i Uil C 1111' 1':11\, cs in I he Ii 1',1 Ctlill n III uuu the dcsramucd cdl in the model :,,,\1 lUll the rcvult I" I he secruul COhH" n We WCIC 10 ick y ill lh"l the reference c1'l'1 (("i 10) was II hln"k vII' nOI used by "iii model. UU.I the spreudxhect is recalculaicd cach umc. so we (li'llLilicii di fferelll vnlucs lor uur II nk nOV,1n faclOI 11. I hUI i s, coition n I now contains 1,011[) '~pl ica: ions or ll'illl S 01 ou r model Howevcr, these values a, ~ ,ull "hot" on tbe sense that a rccalculnnnn will e 11.1 n!;c all of rhcru, We. want 10 chu 1It\~ I hnr , ,Q;

!i1(;lml, 111-12 Ihlll1 Fill l'li,tI"~,,c flo~

~fill!r-:: m- TYr~ I ,t- OK.~
r B.{I!N!; I~ !.'Ma' I': I" ,
t J . "
, (7 I-'OJ;;;;',,: r~ .(i!t,,·,lh I r . ~~I ~: 1~!'"lC~1 I
,
r: .Qal" I ( It .·Ih
r I'~nd r Aulo[,11 l r '~.-:II
~IOrc VaI"e 11 S!!!pVd'.~ 111:(1) 437

Sit'" 1/. I I rghl ,~hl eel I, 12 I h,o,,!~h II Utll.

Slep 12, CI,d nuthc Edilil~1l1 ,,1 the lor of the SIl"C,ld'h~Cl f'll'I' 1I1l' d"'l'down men u cl ick 011 (1)/11

Sl~p /3. Ag;'IIl [lick on the I:ri;1 item (II rhe H,p 'If Ihl' '1''''o1dsileel l'rum I he dropdown menu click Oil l'oslc <;/)1'11111 1\ dialogue hox vhou 111 3ppear \In 110.' screen (' Ii ck ill I he CI rcle i1e~1 to V"iI,e.f 1,1 111~ 11 1"; [ colu on 1'1. 1'11.,11 dick O!<.

We IliIVC '~l'la,('[J the hOI I1U III hn~ by the i r vnlucv. uncormeci ed III lilt' model

{,mphing the Result»

We can "('W uxe lhe numbers r", tuuhcr an,lly,i" ",eluding graph"'/! Jiut lir st , let LIS calcu I:, te IIH' "YCnlgc th rcc- yeru pi 0111 over I he I ,001l I, .nl s.

Sfl'p 14. Move III ce II F3 III the wor hhcci anti t ype ~ 1\ V £llAG £(12: II fin II We next SCI I' P I he II III" fu, gra phn'g I II, s '" vol vest WI) ~ICp., i'I rst , We C reu 1[' " column nr values fell' Ill(' eumulati vc prnlmhiluy (the Y·a~i, of III~ pial). Then We' ~","l the values of Ou, I ,[jill) Illal.\

Swp 15. Ml1V~ 10 c~1I J2 end enter into the cell 0,0111 Move [he ell rIC" buck 10 cell J2, if il rnoved when you enlcH'ci 'he Humber Theil cuck on the LtI.or "~1Il at the lOp of rhe spre"d,hcCl From rhe drnpduwn menu ,dC~1 Fit! From 11.1' ~,tlc menu I hILI u ppcar -" , .. kCl Series.

A di a I, ,g 110 L' Im\ ;'1' pea rs 1)(1 rhe lnlluwi Ilg

Click nil rhc cucle next In (,,1111>111.\. Click nn III~ rirclu next In t, ino« I',

Enter (I,mn III th~ box lahcll:d .'11"1' Enter l. (I III III e hox I;) be led ,1'11"1/1,

Click 01<,

Column J sbnuld fill with cumulative prohabiluy values, ~lmling wuh 000 I. 0.002. (1,003 ... on Lip In 1.000

Sipp III. H lJ::hllght cells J 2 I h rough 110111.

Sh'/' /7. (lick on Ih~ DQW iteru [II 1I1~ top or the "l'l'rnd~heel. From lhe drcpdown

menu. chck nil tht, Sur! ucm

You Will 1.:('1 II ho~ w~rnlllg ynll 1111'1 there .uc 0111('1' column, nearby Click on tllc circle ,WXI In Cllnrillila willi I/U' rurrc«: setectiou, IIlltill,cn click 01(.

Another di.llngul: l>ox appc;,,' Cuck on the crrcie next 10 Dt"rl'".tlll}: rn the ~ I ~I box. Theil chc k OK

The rcsultx 01' the 1,000 uinls \l!lluld now be sorted l'rorn highcs. III lowest

Step 18. Move I he CU "or so 111;', a b I a nk pan of I he spreadsheet appc," rs On the ,~I'('CIl This could he, for example, columns L rhrcugh Q.

!KI WU'

Sup I~. Click 0" I[,C CIi;orI \Vllil,.d 1("['" (vhown III rhe 11I:lIgln) In the IUp 'ow or i("!ln~ Movelh" CIII ~Ill In ,he \11111'·.1 Idl corner of IIIC ~CI'~~'I ,IIKI Illli(1 dOWI1 lilt' InUIi \1; huuon While \"\\1 ,'I care I he h,,~ 1<11 Illc l! ,-aph

SII!/i 20, T he Ii I \ I nl Ii vc Chan Wi 1I1I tI boxes ~I "",1(1 1II'I'Cili III the hn~ '1,.- XI I"

NIIII~(' Iype '" 12:.11 (Jill l'hcn click nil Nrvt

StUI' 21, On the nexi Wli'il'fl hox. chck ou the picture luhuled x·y (Scattes ). and then click on Nnt

St<'I! 22, In the 11(·,1 WII;I'-([ box, cuck nn thc box wuh II,,· gl~rhs ,11llWIII!' srnnorh

rIlI'VC~ Theil cl ick Oil N" \ I

.\/1'1' N. In the Iin,tI Wll,lI'd box, till II,,· 1,,1[()wlllg (1" II"· vuur OWI1 011l1"'1~) Click \1l1 1111' II/I circle next HI II'XI',"/,

Type in [{i~l( I',·unlt' ill the ,ill,' hn~

Type in ;Millioll $ 1Il1h~ x-o (/1 h{)~

Type ill Curuuluilve Probability 111 the Y-{L\'/,\ bux Then click (Ill 1-"1111.1""

A chur: graphln~ the probubihty or oh!.lIlllrlg X or mnre profit should r~\l1l1 For (:XIIIIl ric, \ here i, IIPI'I"OX i murcl Y 'I n HO percent cI"l nee (lull the product Will shnw <I PilI; II vc profil illlU a 20 pc recut C hu !In· 01' :0 I oss,

You may wish 10 l11mh(y me r' "ph h~. 101 example, addl1ll) ),\"d hnc~ ;I"d moving the )'.t\XIS I() ti,l: Il-II, hlll Ihe~~, nll\lnll~ life beyond rhe ~eorc of this IIII",,~I,

Summary

The purpose of \111 -; I utorial was 10 step you through hurldmg a sirnpbficd example. II mode I of u reul hllsi ness decision I nay he much more complex ami II' vol ve more uncerrauuies. BUI the basic idea, or IIli, exercise ,1101l1d enable you \("1 build ,,"d ,j n n I yze I hese In U! e com plicated proh I con,

Bibliugraphy

,I

I b II, I), 8 . "nil H I' IHlllla~ /\ is 1: /\ Il III 1'.1 " "'Iii ill' "1'11/;((111"1'15 New yo'~ luhn Wiley & Snns , I 'lIP lltlhcr. F" lind G. J. l.rehermnn Introducun» '" (),u'mliorl.-'i: ~e'\·l?,urh (ltll cu. New 'for,",' Mdl1'awHIli 1995.

Kh",h nev ". B. Di$crtlf .\ •. II""L.' Si,,,,dm mn New York.

McGraw-Hili, IQQ~

low. A "4 .. and W /) Kc·II"" S,muln""" M"drl",~ mid "",,"·rl' 2nd "01 r"'"", York 1I.lc1" .IV, I !oIl. IQ'll,

rl;'Ilc. D I! '11nllng"'''~1I1 Srtrncc. II .'1/"'1'(1,;,1,,·,'1 "/ '1''''''' /1 /OJ- W",d,,~' 1 11<11, vcrs, M J\ 1><o1d I<:

I rnsi-r puhl i,11I n£ en, 1<)')(0

R"~~d"I,,. Co T SpI'r<l,I.I'i",ol ModeliIOg ami /lfr:"ioll <\/1,,/,'''' Cambrrdge , M i\ Course Tcchnoll'IiY. Inc. 199~

S"";'l~"' S 1'".(1 QM, New Ynrk' McGraw·Hill, I ~'n. S('h I Iht~l, r J All 1m rodur lWil to Sim uJr.H irm t\~(.~,V' Yo, k John Wiley"" Son, [9<J I.

Pra c (i ee Pre) "It'111,~·

10-1. ", U,i ng the !"'"(' hi ,Inry fir "Hi v,lll ,I mw 11 in Table 10-4, \lInUI,IIC Ihe "aillnll hue I""~C" nf 'he. w,,'cllml\'· railroad em """"I'le "·,111 a consrnm S~I VWt: flile of three ref .... lily,

h i\ ,,,",11 ng <1131 I he WII I chuuvc cnmpally P,I)'~ $11)0 per duy fn, f,clghl cal' kept 0"" one day, ,·'I"n;oIO the nnnual ,,,ving~ (J65 d"y, .. I year) fro", " ser vice ,.1" of th ree per d~y (II,,,cad of '100 [lCI day)

! 0-2. Conunue Table 10 In 10 50 IrOn I" ''', "/' raudorn numbers r rom Table 10 2 1'10'1 you, re<ul" n" iI

(I i LIS'" ITI srrmla r to FiR"'" III 2, 0", of Y"" I vn I r1 pic or 2.~ I ri"I~, whru i, the I.",hll hil i ty nf the pl'"li I he i Flg Ie.,., (hnn /t·m"' Whnl I' the '1\~"'l:c profu fOJ your "'mp!e of 2~ II '" 1'<' Compare Y~u' "",Wcr wuh I h<l'" ,,1,1'''''"([ '" Iuble 1(")·10 and with Ihe expected prolu ... 1 Oil. III n1,lhof1

111-3. Itder 10 Prohk!ll III 2, SUPPO'" Ihnl Ihe sc lling price "'HI annual '!lIe., '<111\ me were "01 II,d"p<!l1dcnl

vnrl IIhlc~ bu: were Jnl" Ily .Ii;! nhu led wllh I he lullnwi ng prnhnblill ies, ~Ol" (11.11 Ihe margllla! prohabdn,,·, arc Ille snrne il ... 1 n the chapter I but now. rhe assu Hlpl urn f1f indepenncnce does nOI npply,

", Sin'l'ly by ,!udy'n~ lil{" nccornpany '"1: 11\11\1 probabrlny raule, cnn Y"" prcd,cl whether expected pmI'll under the m-w ,I"""'pl ion will he III &Me, or lower I hun prcvlnuvl y" W by Or wilY nOI·,'

~.19

/I. I )ov"c U scheme '"\111", '!' luble In 'III"" """

I nurlorn numbers 1<' I" ", I""l· rn ,,(10m "III,,", fnr I'rtCC ;[[\,1 ,,,I,, me who" Ihoy iII'" related ns 'pee i Oed

e l1,c Y"''' «heme III (b) (0 generate 25 I "nl' of ehe 111V",m'CII! ns I" Tahle 10 Ill. but now n""lIlIlIg

pi lee und vel u me arc dependent "., 'P"c,III·1I

d Piol ~ ligure ""HID, 10 I· 'gllrc 10-2 [nl ) "'" .tala ,n (el

e enl'lpar" your fi gure tlf (iI)lo Figure I () 2 W hich II' VCIIIl,cnl would ynu prefc r~ Why"

Prohlclm

--- -- ---- .--.----~-

III 4. enlll inuc Table 10 7 1(1 100 periods L" '''~ ,""dOIIl numbers [rtun lahlc 10-2, 10:"'"1111" III~ roial

unnunl C<I,I (I year SO "'"ch) 'f the COIl <of p'"cing

nn ""Icr "S I O. the ~",I "I holdlllg one unu 0/ irl'c,"ury i~ 50 cents p~1 y~dt, and rhe ,011 or outage is .~ 1 per unil of lost !alc~, (Usc a veragc beg"'" i nil '"VOnt'" r on dc'ermm',n~ em, of holding lOvt"nlmy.)

1.0 S, ric k an i nveruory rule that you colllI<i"r gnod for 1110 ~ilLml ion descri he!1 III I'rnhl"m 10-4, ( I' hOi II. pick

T,IIII.I', 10-12 I'mhlll,ililics fur ['rohlcm 10-6

l'ltrt' (/11'1' 1"1,1,

~.1 1

oro 0,2(1 Q .1/1 010 (l,(ll O,O~ 1,00

u runubcr Q and a number N,) S,,,,,,I",, for 100

pc norls. lll,d compare lile ells I of ynu r ru le IV" II the CoSI '" I'rnltlc III 10-4.

10·· f,. J\n Id~ho porarn far mer,s !IudY'ng the ro< ks "'I(lC I uterl with pi ami or, 1m potato crop 13 rI'cri on 1,",1 experience. he as~e;lc.\ the prcbabiliiics u~s"ciEl'!ctl wuh pnWIO proce, per hundrcdwcll!hl tcwt.), YIeld' In CW'. per acre, and cOS Is (10' f"([lhl,cr. water, ,.o(!, and Inbo() per acre (see Tnl,l" I 11 I 2),

Yw/rl CO,YI
(f'LLf l~fl'j on'" t)rohrjhjlrl)1 (I'trGNfn II,u'mhthry
----
210 o 10 5"00 n "0
no o 10 .100 U,20
1m 040 600 n 10
140 0,)0 1110
110 010
10() 440

The pl'Clr" per ant is (Pricc : y rc 1(11 . (,,,s I .'\ ,''"'''' "1.1 probnbil i tics A rc indcpcnderu Us "'g Ill" ,\,,, "'(0 [·,11 10 met h~~d far 25! fI ['11:-::, C~l i nmlL~ ~ ht' t':r;: pee I ~J proh1 IWI

More Challenging Problems

l D-7. Refer to Problem 10-6 In renlu y, L I,,, price Hnd yield (He nrn uidependen I vnriahtes. A low ~ icld general I y me" ns :1 shortage of potatoes, ;;') nd the price ,·i ses ; a hi gh V ield mea ns low prices. However. th is rehH ionship is 1'101 ex-pel. as there iHC tH IH.~r L,H.'::lor'\ he"dc\ yield, 'h~1 "ffeel prices. Suppose I haL L he ~',el(I

a nd C:O~l pel' acre HL"C l hr: snrne il~ gi \'Cll ut Prohlcm I n-6 a nd are independent S "PI,C),e. fLin I," r, I luu price i \

rei HleG 10 y lcld by I he fallow i ng "1"'" i(" ..

r,·ice " 15.5 - (1.(1'i(Y icllli ' I)

where D is a rundon ..... arinble i ndicat i ng [1 dcv i m inn F rom I he equat ion. D has tile [ollowi ng d istrihut ion (i ndcpendcnt of yrcld and cosn:

[)

·51110 Gill
_. 0,0 0211
o 11.-1(1
0.50 () 20
I.UO 11.10
I Oil bli In"'e tbe .'I'c"cd pru~ t per oere alld Ille

d i.wibutiOIl or prO);1 rer ac ,·e u 'ing tllC MGOIC Carlo meLhod wilh 25 !L"i"ls.

10-8. An a n" I yS! [(II· InLerlm ional Widge" Corp. (IWC) was worlling un Lile corporale )il1~llci.11 pia" fm

I he nex L year_ I \-VC has t INO major d i ..... isions.. One in L he lJniled S[i:Hes H nd lile nthl~r In t Ill,.~ t hwed I( i ngdon1, From lhe martageJnCllt or cm::h division. [Ile arH'I1Y:-1! h~Lci nbt.Hined an .i:ls.l)CSsrnt.I'L or lh~ prohahility dlslribLiliol"l frlf n"1 profil lur Ihc "eX! yea,·. -r"hle 11i-13 (ncX! p(1ge) list::: II,c:sc asse:ssrn(!n(~, SllprO!1C! il J~ I'CH."i.onnblc lo

H5..~ll me dH.:: dislril':lLJI i~ln~ [ire I nckpc Iltll:Ul.

(I SCI ur a prtH.:c{lmc, USillg MUBll,,': C411·10 Inc l hod.l;" W CSI i.rnnle I he I'mh~bil il)' (!ism I," 11M (01· CUIll billed OCL profll for I We. COLr r y ,"" iI," I" occdu rc for Ii "c Monte Carlo I r",l, 10 i IllISI ro'e how iii, <I~[lC

" I mh"~[e how yml wmlld "hlll i 11 lile probobll;l, di~';[l'ibLHion of cotllhined IU.':t profil rrom Ih~ MorHc Carlo rCSu II,.

c. S uppo$e the d i.l'nbu, i005 were 11m con ,iJcred indcpcl"'ldent (world economic conditloll:S tend In

.u.rc il rlfl ! II e l)I'oh~lbll i!y disui b~H inn for pl'L lii( per acre. W 1];11 i, I he C~I i maled p'·Qhnblili y 11\"1 the [arurcr ",,'k(:~ Ie" 111;11' ~ I Oil per acre (Ill hi, ""'I'"

a rfccl ;111 count ries W some ex reuu, 'lo handle [11 i s problem. ~ 11C ;lIl:11 )1St pl'opC"'Ises to use ~ he same random nu rnher in deter III i n i ng Monte Carlo "'I11I'I~d val ue both for U.S. and U. J(. profit: Do you ngree with rhc procedure? Cornrncm hne~y.

I {)-9."J Thc Acme Airline Company IAAC) is concerned about schcduh ng rI S engine repair ,hop U1l(lc r altc ,.,,,,1 i ve A. engIne fepn ir 111",'.1 w,mld he

C~ I',,"enl, H Ily d lSI ,.,b", cd WII h a ","an I i 1I1~ 1>1· ~O d:!y'

U nrlc: ij Ilcm4111 v C I,. (n I nore COIl1 plex prnccdure). ellgi ne repair umes would be nnrmally distributed with a mean of 40 day, and 11 standard deviauon nf 5 rl ays.

When an engi ne ani \"1;5 tor rCril if. a spare engi ne is scm out ro take 11$ pi ace. The engrnc requ i r-i ng rcpnir i s l hen SCI11 ro L he shop'. a II engmcs under repai I' are workctl on SiI11qlll~ncously. \Vllelll repairs hnve bcun (_'nl11rICI L;rL II,c repai r ed engi nc enters ~ he "spares pnnl " [0 he used 111 "i'Hi~ry .1 subsequent rcqurrcmcm Engille: 111' rivn I So lur r~pajf iHC POisson. w i~ h rate A ~ 0.5

per d~l~.

1 f n n I;llg i nc ani ..... L!~ when 111C.f~ arc no SpMC e:ngi nes 10 W ke 11 ~ place. ;1 ~r(.HU engine 1:'\ ex pcd itcd j rom

'"'''' her locnt i(1I1: I h is co,,, $10,000 pef request. A AC has P" rc I'~'cd 2 ~ spare engIne, I n meier I (! k"cl' I h~

h kc I, h()ml of e,xpodill rig low.

NQ[e llHH since r:ngine repaLr t i mc~ .jHC not COI'].$[;fI I'!, cngi nes l1'\il y "Lm~s" in. U1TH~', lhJI l:'i. an engine I hal <{nll'eo "llile fep"ir filCilily I.[er ""y "cIlially be compleled <"rli~r.

Dcseri be CJre I"u II)' how yOll would si mulaLe 'h i., ::;.i lUil[ if)!l. i ndlld i ng t'_:lch {)r I he followir1.g_

I·bnc.h'lm c.ngi 11C arri 1,Ii:J I s

Ram.1C"11h C 11gi I1C re:r,i:] i I' L i nlCS (lHH.ler c~idl allc.J'n~H i ve). The n u m lu:,r or :;::Pl'l re_1i. a ..... 11 1141blc ;1[ H It II 11'(:';:;,

Tht:: n Lui1 hel' or ncc.:url'l::.ncc~ or ex i"H;:d I~ 11' l} ,

YO~II' i ["Ill iill i :t,~IIIOIl 11 .. 01;(: .... :;

10-10." 1111 A''1<1I11i'"C Similgdll.elricval .'i),'le,,, (ASm s 1 " " ,n"'rUICr·COnl rollell ,kvi"c I"r,,·

IOThLS prol~I{·rn n!quire~ kIHlwlc.d,b.L. of 11.lL'lLCrli.ll 111 ApIJCrltJl.~ I LO I hi_~ dlft pier.

IITlliS pf['1bl~ln i:s Ltd<lpled [rom \V, 1-1 HaUSlm~ll. S. C.

GnlVC"5, .1nd L. B. SChWflf7 •• -'Slmlllalion Te~[s, or I\LtLOnl1llic WLln,.:twu::.illg SY:!i[Ctm," AI£[ TruH.\'l,7c'i(JlJ_~, .seplemh{!I' ItJ7fL

.:~ .;:

.'.'

- ~

44 [

TAlJI.E 10-13 (for Problem IO-R)

IJr{J/J(J'nitl.\' of

,'IIJI(11011 Ttns \111(/' Profit

r5IlflUI(HIS) or t-ess

-~ 1.0 n oo
].0 niO
e.o IU5
R.O D.30
10.0 0.75
1.\.0 0.90
20.0 ].00 U.I(' NOI I"U"I

,·1IJr()WII {fmrl-(!rted 10

U S ~~ PI IJlj!fwru J

P1'rJ'm!)r'lil.\lof fhis M(j"h Fro_fj, Llr' tF'.'i.'i'

so .' 0.7 11.9 1.0 I..l 2.0 3.11

000 1l.IO 0.25 0.)0 0.75 0.90 1.00

warchousi ng 111<11 ell" ~Inr" 1''' lie Is ol' 1l,"lcriul hy pick i rl~ one up "I n conveyor; ",(] pickup/deli vc ry poi ru ;' nd rnnvmg both vcrticnlly and horiwn!alll' down "" "i,le until an open storage locat ion fm the pallet is louud. When a retrieve request occurs, the ASfRS travels IU the locat ian in which I he designated pallel is stored, pu II, out the pn llet , and del i vers il 10 I he pickup/deli vcr y poinr.

The ASIRS can be desc ribed '" a rallel loader Ihal can be moved "P or down a "mast." which ",II., {J~wn s storage aisle: There arc locar ions on cit her side or the "isle for srorugc. Consider an ASIRS with a 'inglc IIi.<1e (l, Suppose arri vnls of pallets, to he stored arc POI sson,

as me requests for retrievals of pnlletx ntrcauy stored. A lso, suppose I he ··I"'V ice ti rnus" (i .e .. I he umc for

I he sysicm 10 per lor III a ,IOfC Or J retrieve) are e'poncnl;ai. SlIPPO!" ~Iorc, a"d rClr;cvc, arc dane scparme Iy. and .<wppo,e " ,i ngle queue ex i~" covering I,oth ,,,,,c.< fHld rClfi eve r"quest,; "1,0. I"iorily i., ri,sl·come. "rSL·,erved. How wGeJld you approach Ihe prohlem of analyzing s"ch " sY~lem·~

Problems for Computer Simulation

T he problem, in I hi, ,ecli on a."w me I h31 Ihe IlIl,,,i 01 i 11 Appendi. 2 l1a, b"en dono. They "re dC.ligncd for Illc r: xcc I s pre" d, heel.

10-11. A sor,w",~ company bas in!roduced fJ new g"me, co lied Build· a· Cit y. T he company offer~ " lelcphone he I p line ror w.,er> of Ih~ rrograll1. "1"1," 11.1 P dc,k is 'lOLffed by One per.,on knowledgeable abOll I Ille B" Ille. I r Ihal person is bu.<y answering" Cll II. Ihe teicphone sys LCm I,uts I he caller On hold LI n! il I he hel r person .s frcc, On avc.mgc. [he meafl iruerarriv;al Lime between ca lis is 4 mi nmes. and On average i I lakes .1 mlmHes to answer [he ca Iler '5. qUe.S,L ion, However, I here

I Nor": The ~1J III or I wo r"i,s<m precesses " a ~all' Poisson.)

h. r>'ow SOl nposc I lin I I wo separate queues are maintained. nne ror SIOJ'C;'o: lind One [or rei rieve requests, As5U Ill" I he opcr at i ng pol icy i s Ih~1 ,'10',,, and retr-ieves arc now combined (us long as both queue, are not empty) so ,h:" the ASIHS do", ",1[ ,·CLu rn '0 [he pick up/deli very poi rn cmp'y. This ccrnbi n i ng of stores and ret ricvcs naturall y increases the perfor rna nee of the "i.:-tS[cm. A vsume service

,i mes a re SI ill ex poneniia Ily u i stribu ted. bu I with a smaller mea n. How wou ld you approach the probtem of analyf_irlg ihis system?

c. Consider the shuaiion ill Ii,). bUI "OW assume that the Asms can selcc: retrieve requests "01.11 of order" in order 10 !ry 10 minnru/c wasted I,..,vcl urnc, Thai IS. given ;] dct:l~ion 10 storl;.': ,) pullel in 1:.1 given localion. il may be Ill'"'' cJRci.cI"I I 10 do OIlC rei ,;~v~ rulher lil"" another bec"",e of Ihe loc." ion "f Ihe relficve, in lhe r"ck. How w,," Id you approach Ihe problem of an 01 Y'. ing Lhil ,y,"ern?

i, considerable v/H;:1bil;1 yin bOi h arri val" '1d servi,cc Ii mc,. 1lnd Ihese ore ill(lepondenll y (j i miIJulcd. both wi I h cxponenl i nl di~lfi bulion.l. The company waniS to e'ti ""lie Ihe "ver~ge wail ing I; me I'or a c~ Iler. (10m

]111 rpo.,~s af Ihi S q"c'l i on. 11,5,,1110 Ille ,"Ie of '" ri w.l. is Ihe same Ihrougll0UL Ihe cloy. find Lllal "0 caUer haRg< up before being hel ped.1

No/c. The MIMII qlleuing model is a cJ8S5;C1llmooel far 'Ile si ogle SCrver queue. The Illodel assLlme~

i nlcr.arr; \,I;:d limes thoH <!lie d i S~ ribl,Hed tiS i?In C:;II; pon.cntlJl! or Markov diSlri buti on. and service times th at are Independently d;~lfihuled. "1<0 by on "'pon"n[i.1 Of

1'V1.iJrkov distribuuon wuh nne service channel, ~t'C

A I'pcncll. I for a discussion or Ihi, (1i<1 1'1 I1LlIIO" TI", 1110del call be solved Ilw(hCm:lnClIll

Lei: fl.< be ihe mea" 01 the distnhuuou "r iruerarrlval umes (III-<. is Ihe "HI""I ralcl

u-s be {he mean of Ihe drstrrburion of ccr virc ti mes (II fl..1 i I the service rulei

The- suuuluuon morlel :s.el lip i'C'JI [hi\:, ~11'm1411Inl' 1"shuwn in F'glil'" 10 13. Clller 1i1~, i1clLllings I"lei lill IlL rbc cquauons ," shoWI\, SCI lip the I"oclel lO sunul.uc 1000 Joh "'fi 1',,1, (i .c. calls to Ih" hel p desk I Refer 10 Appcncux I I;, .. ihe I1lCIIlf>d for sII1'Hriall"£ the cxponcnual <1"1 I"i 1>111101l , Fill in the first column with job numbers. and copy cells B JO Ihrough !lIO dow" lO

[ll Illlq throuah HI 0(19,

IJ. SCl up ,11; sunulariou rnodel as described Using (he model. sunulnre I.noo job arrivals (c"lls). Usc 111e rirs[ ~O(l us. swrwp, and calculate the average waiting umc for the 0(11C' 800 calls, Compare this to 1110

I nenreucal value l;aICU~1Hr.::,1 r,.om IIH~ rc~rmula above, ,\re !lrey exactly ibc same? Should Illcy be"

p = t:! be the system load facrnr or urilizauon 1.1. .•

Then [he long rUIl average WHiling rime. Mil', IS givclL by ure lorrnuia:

M.I· P It'll' ---I (J

f/'GURI'; IO-lJ Setup rnr Simulat inn "I' ~ One-Channel QlI""~

.,

b Simul~," ~ nOli,.", I.OGO H ITi">I I, Ill' push i ng I he recalculate key (P9), A~ in part II, <iisrcgill'Cl Ih. J\r~( 200 ruals ilild calculate the "vcl'age of Ihe I:Isl 800, Compare thll 10 your result in (a), <Inti 10 111e

I hcorct lea I rcsu!i.

H)-II. Refer 10 Problem 10-1 I. SUPPO," I he sof': ware producer could develop a supper: 'Y'(CIl1 for Ihe person On the help desk. TIllS mighr lake the form of II computerized expert system, lor example, f\sslIllllng thai ih i S would reduce 1 he average service lime !O 2 minutes. what would be the effect "" the average waiting lime of callers? Answer by boih sirnul.u ing the siruarion ~!ld u,ing 'he rhenretical model.

10-13. Refer 10 Problem 10-11 and Figure 10-13,

(I, Simulate the queuing system I'm I ,ClOO trials for each or rhe follOWing nvcl'agc ill(cl'flrrrl'al ruics (keeping

I he 11 vcragc service rille of ,) nunu res u no hanged):

},5 minutes

6,0 rrunurcs 9,Ominules

b. The utilizatinn or 'he queuing system is rtcfmcd 10 be p ;;;;;:0 t:l or [he average. service , i me d ivided by I he

fl-A

average intcrurnval lime. Usi ng I he rcsu Its of each of the C3,CS In par: (al. and the rcsulrs of Problem

10- I I. plot I he avernge W>I iii ng II me versus the .systclll tUilil,,fHion factor p,

10-14. Refer In Prnhlcrn 10-11 '"ld Flgtll'c 10 .. 1 J. Suppose the I i In. hel ween arr i val, can be represented by a normal disinbuuon with mean nf 4 minutes and standard dcvuulon of 1.5 minutes. Purthcr suppose thill the service lime can also be represented by a normal dis( rib" lion, wl I h mcnn of 3 min U(C5 and ~'il ndn rd deviation of 1.0 rrnnute.

a. Modify the model ro incorporate lb;s change, In particular:

Replace cell 810 by = NORM It'1V(RAND( ),4.1.5) Replace cell C 10 by =NORM1NV(fV\ 1)( ),3,1)

and copy these cells down through B 1009 and

C I O(]9, Nore (he change in Ih" average w;lillllg lime,

b. Keep 111e mean service lime "' J minlJlCS hili decrease the xrandurd deviulion of service rune 10 0.5, (Do Ihis hy cllanging cell C I 010

~ NORM I N V( RA N D( ).J ,0.5 I and copying il down through CI009.1 Note what has happened to (he average wail i ng I imc.

c. Keep the mean service time at J rrunutes bUI decrease the standard deviation 10 zero Iconsrunr service, i me). Do rh is by replac i ng C I () by the value

;I, nnd copymg ilus down through CI 009, Note whol h,IS ha~pencd (0 the It\'cntge "'Iriling urne,

rI, Whm cnnclu"i(>n would VOU UrI'W from Il1i; about the effect of vanahilllY ,;) service lime 011 w"ilin~ lime m a queue?

10-15. Refer I" Problem 10-11. Suppose rhc coils for help 10 Build· a- CUI' double. 50 that the average

interarri ".1 time is 2 III mules (st i II ex ponent ia II y distributed). The COI11I'BI1)' decides to add a second help desk: with" lelcphhne system that will reed the call to whichever help desk 1\ free or keep the caller 011 hold until one is fl'cc. This is called" two-channel system. Figure 10-14 shows how (0 set up rhe simulation of this system. SCI ;1 up as directed in Figure 10-14. N~'e that service rime remains ex pone", i ally distributed wi 111 mean or J rrunutcs

Q, Sirnulruc II", system for 1,000 fLrrival.,; discard the 11J'st 200 and c.nicu/alc the average warung urnc fI~r l he .,L10S0q"Cr11 sno,

b. Compare this to rhc result you go, In Problem 10-1 I (either ihe rheoreucal Or calculated value). NOle that both the arrivals and the service capacity doubled. Do you gel the '1I11le rcsuh as in Problem 10-11? Shou ld you" (NOIo.- what you observed IS ca lied 'he effect of pooling of xer ccrs Or rislc 1'00/iIlS')

10-1 G. Exam pie 2 in Ih;, chapter was a .s i rnul at i on of an rnvcnrory system. I-:igurc 10-15 (pages 4~5-46) In<Jif;Jl1CS how such 11 srmulatiun ('':'In LlC SCI up on a sprcadshcer lise rhc sleps below:

Set lip 111e sprcadshce: headings as shown in Figure 10-15, lnclude Ille prnhnhililY distribmion« I'm Demand" nd Dcl i very l~fJg i 11 colurn '" I. a 11(1 M. '" shown.

In column A. pu: ill [OlH startup week, indicated by "x" and then till in rhe week numbers frorn I through 500 (for si mula, ion of 500 weeks)

In column B pu, in 500 sampled values From the distribution of Demand in columns L and M. Do 'hi' using the procedure in SlCP' J, 4. and .~ ill the nrsl example ill ihc unoria] ;11 Appendix 2.

In column C. PUI In 500 .Ia 111 pled values from 'he di,,,ibulion on Delivery Lag lime, using the same procedure,

Fill In the valll"~ of zero If I cell EI O. in cell, 17:110 ,,,,d cells J7:J I 0,

Fill in the value I fl in cell G 10, tile value 5 in cell C2. and rne value 5 ill cell CJ.

Enter the equations for the model as show» at tile 0011001 of Figure 10-15.

Copy cells DII 'hrDllglJ JlI down to DI2 (hrough 1510

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r'rGUHE ] ()-] 4 Setup for Simu]ntion of a Two-Channel Q"CUC

o. Calculate tile ~VCI'RgC values i"OL' 1.(10' Sales Ou'age, and for EIl(] ing In vernory,

b. Try different values for Q and R (v:,lucs in cell' C2 and C3 j ,,"(I nore me reSU]1 on 1 he "vcl""ge.'_

10-17. Refer [0 Problem 10-16. MOle tha in ]'roh]cm 10-16_ any demands that could II," be mel from

i nvcnuuy were 1011 (Ille ,0 - "ailed los: '" Ie, case). Now '"PI,OSe [hat un Ii lied demand.' can be hackordercd. Relabel cells H5:H6 us Un;" B"ckordel"ed_ and describe how you would modi fy yo" r spreadsheet !O deal wi III this situ aL ion.

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445

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446

I',

Solutions to Practice Problems

111-1 rr, Tile lowl "u Il1b~1 del "yod 10 I he I'ollmv'ng d" y " 6 I'''' uverage 01 11,12 pCI' <I:lyl,

h Cost of w:ullng wuh service rure of 2 ClU'S pCI' day IS:

Cos. Dr '!,Natl ing '..vi ih service r.uc of J cur-e per flay 1:'i.:

$100(0,12)13651 = $'1..11<(1

Savings is $:12,850 - $4."80 = S2~A 70 PCI year, 10-2. Re.,,,II' will depend on Ihe randnm numbers drawn, A~ stated ,11 ibc chapter, expected profit is ~2, 1-1 nullion. AI,,) " negative prolu rc~,,11S when Price" $4 ~"u enS! '" $4 (l'cg/ll'<llcss III' Ihe volunu-). '''1<1 the prohabilny of n In" in 11m luxluun ,~ ((j,3)(OJ) ,. !IllY, AIS(l. }l Ins~ can occur when ('n"ll 1$ $4 iHH! Price IS !fi5 ami V"llImc " 3 or ·1 million. Proh01I"bly ~ (0,J)(0,5)(0,6) " 1109, There i" also a loss when CO,I j< S3 and Price is S4 and Volume" J 01' <1 million, Probability = (0,3)(06)(0 6) ~ n 108, Total probability ~ 0,09 + 0,{)9 L O. 108 = (U8H.

447

111-.1." Since rhe 11Igl\01' PI'ICC 's ,W;OCiiIlC(i with the lower v('JI~II"c jlJ)d Vice vcrsu. IllI'':: mdrcmcs thnt when the lughcr IJ .. icc occurv, pmtl.< will he 10WI.::I· ~ 11i1r1 before. H nd when ~ he lower

pm .. .e occur s. low profit m':lI'glns (or f1C~(tu"C lI"1argi'H!') will be multiplied L)y I~lfgcr volume ..... The general effect should he to lrvvver expected profit.

f" Use the j'oI10w,ng table:

'S m1l111>11:Randnm nllilltJ.l.':r~

r. d, unrl e arc straiglnforward us~ng rb)_ Rc~ullr,:; depend on random numbers drnwn. The expected peon. can be calculated as ~ I .66 11111110n

M"I\Vi'll,,~ Exnn,pl.c

Oi I Plat forms in the, nrt h Sea I

S i nee 1966. I here hn '" been major 0; Ie, pi or aU "" ac I, vuies on the Noni, Se, off the CO"« of Nor,,"y L.dch Inu, vidual plat lorm pr oJc, I rnay take from 1111 ce LO Ii vc years 10 construct. III n cost DI O"OLl[ $70011' ill ron. CIII;Cltl path method, ,uch '" [hole de,crihed II' 11m d','pl.r have been used "~I~"'''''''y 10 plan und curll,,,1 ,,,cl'II1J~c eClnWUCI "'" 1" ()I"~l'. The iniuul fO~II' "'.IS nn project comple,1 ;"" lime, [tn! cu rreru HI'lll ouches III "u include eJellle.ll .... of lui-.' and resoun .. .e • C-4LJ IrC~ ,"em, Momc C~rl(l SI mul,ll;nn II", been npphed, hUll!

1_

44R

on ccrnplet "'" lime and on proJecl c ,," eWlllate,. I~· Icgralln~ 11II1C, ""I, and reSOUKe requrrcments has been ~huw II to he very i mporraru ~ 111111 ted resource:'; allen plnv , I1WJD' role in derermming which activirics can he pcr lo"I1('d ~I Wbill [i me,

'See 1"'1 Willy II.Llarld. "Toward 11111"'"10 Cnrarol of Meg~Lprnlt't: iii lli I h~ North Sea." i I. CJfl'ml Proit1r.t MO"~R'''''tll 1I",,"II~n(, Chaplo, In. '<l l) I Cleland "11,1 R Gon", f~ew V,,, k McGraw·II,11. 1'1').11

C II i\ PTE I<

11

PERT

Program Evaluation and Review Technique

'1'111 s chapter pi'e:;" " I ~ IOnl, 10 111/1" ;i~C I Ill' pia" ILl rig :11 ,rl '<11111111 Ill' rn fI.i 01' 1'1" 1<'(' I, with '''illlY o;CI'IHIlI,' :H;11VIIIC' rluu rC'I1I1I U ~1"II'(JitH'lI<ll1, 111 "'lilly bllsil1css sil'"11 ilOm, " [lumber of <1lff""'1\1 ,IC(" n ,e' mus Ill: perfrn rncd 10 a ~p~CI hrd '<tjucncc .n ""k I 10 .rccornphsh "'1"" 111111"1' project <;orne nf IIIe acnvruc- 1II,'y he 111 sene' ([",. C~ 111I11'lc. market rC'~11 rdl (,,1111101 be rerl'ol Il1crl before 111~ r~\L~:lrtll lI~,'gl1 is rl<llllwd 1. whereas orhe. < Illay he rn pnrallcl ([,,,, "xHrtll'le. the el1gi!lc~ Jm 11 ship c~11 he hl,,11 aI the same 1I"'~ the h,,11 j, heinp constructed ) For :1 I;"g~. 1I11nl"'lc~ prnJcn. 110.· ~()In plete set 01 ",'11 VlIIC' WI II U.' lid II Y cnnuu n a com hi n;1I1!l11 of 'CII e~ ami pal III I c I dUillCI1IS. The technique "I' P[RT (1'1"111;1'1'''1 Evuluaunn IWci Ikvlew Technique) I, deSIgned 10 Jld :t 1I11L11"g~r 111 planrunp "nd cl1l11rnlllng vuch a pi oiec: FOl" rl:lIll1ll1g purposes prun 111 the "art of the ploJect. the PERT technique alluws a mnll.ll!cl to calcu I a IC tile cxpI:('\('d 1< nul "moll 111 nJ II me the C IHI I"C I" L 'I~' I WI II Iii kc !O corn plcic Tlu; technique higillil'im 11l~ bnlllcm'L'k "~I ivitics ill Ihe pl'l1ic~1 \U l11l1l the 111:<11<11\['1' may either a 11(1(>11.' 111<'''' resources 1<> !lWItl m keep :, c;Lr~I,,1 watch on I hem '" II", WOlcCI progrc\\c' II" purposc« 111 ~UI,,<o1 aflcr the pnnccj hm hq:IIJl,rhc icchmque provides n W:lY <If 1II'"lilolln!, progrev- oIml calluig attcnuon III those delays In ncuv "IC, Ihal wil l C;lLI,,' ,I 1Il"i"y in the I""()ICCI" cornplcuon dale

Th,is chapter pre-em ~ the ba,l~ concepts of PE R I IInd('1 cond LI ;ons of hnl h known and unccrta in ac uvi Iy t, me'

Ill/Ofllla/ioll R"f/llil'l'.IIICliIS

In order 10 ~I~C l'r':lfi, 111'(1 types of mfur rnuuon <Ire n~~,kd 1<11 e.ich act I "'Lly ", Illl" plllic~1 l The ~l'r/IW""IiI\' I"I'qllirCI11(,1I11' rell' "11 acuvlry n1LlSI I.~ known For example, we need 10 know [II,' 'ci or ac II vi 11[', thai 111U~( be compli'lc, I prull to 1 he hC!(1II1I1I11! ul end] specifrc ;'C!i'IIY. In addruon. we leqUIre an CIIIIIlillC nl the nuu: each "ell' Ity 11'111 tukc,

~A erosely rcl:lwd rHOI t'.hlll! called crM (Curlrlll r~llh .\"elhnd, .d~n C:\I~.~, ln lr-m r-hnr][cj IIII' ~4.:1 11I1.mlngy of I-'Elfl 1" used ~ ~III hough I he 1li::1 W~'I k d nl~rilPn procedure jollnw~ ~hl;! I;:nI1"'cJH Ion nf r'I}M

44\1