Decision Models and Optimization

Indian School of Business

Homework 3

Instructions

1. Please submit your homework solutions through the LMS as a single pdf le.

2. You are not required to type up your solutions. You can submit scanned handwritten copies that are

legible. It should be possible to understand your analytic model, the logic that underlies it, and the

steps that you have followed to arrive at the solution by just looking at the writeup.

3. For problems that require you to build and solve a spreadsheet model, include a print copy of the

spreadsheet model along with your submission (that is, print out the excel spreadsheet(s) to convert

them to pdf and include them in your pdf document).

The print copies (pdfs) of the Excel spreadsheets should be included in the pdf le that you submit.

4. You may also submit the accompanying Excel spreadsheets as additional les. However your pdf le

should include the print copies of your spreadsheet model as described above.

5. There will be a score penalty if the instructions are not followed.

1 Playing a chess tournament

You enter a chess tournament where your probability of winning a game is 0.3 against half the players (call

them type 1), 0.4 against a quarter of the players (call them type 2), and 0.5 against the remaining quarter of

the players (call them type 3). You play a game against a randomly chosen opponent. What is the probability

of winning?

2 Hardware store

A hardware store has received two shipments of halogen lamps. The rst shipment contains 100 lamps, 4%

of which are defective. The second shipment contains 50 lamps, 6% of which are defective. Suppose that

Emanuel picks a lamp (at random) o of the shelf and purchases it, and he later discovers that the lamp he

purchased is defective. Is the defective lamp more likely to come from the rst shipment or from the second

shipment? Explain your reasoning clearly. Show the necessary steps that lead to your conclusion.

3 Limousine pickup

The number of passengers for a limousine pickup is thought to be either 1, 2, 3 or 4, each with equal probability.

The number of pieces of luggage for each passenger is thought to be 1 or 2, with equal probability. Moreover,
the number of pieces of luggage carried by one passenger is independent of the number of pieces of luggage

carried by another passenger. What is the probability that there will be six or more pieces of luggage? Clearly

indicate your steps and reasoning.

4 ITNET, Inc.

Anders and Michael were classmates in college. In their spare time while undergraduates, they developed a

software product that regulates trac on the internet sites. Their product uses very imaginative and original

ideas, and they have applied for a patent. They estimate that there is an 80% chance that their patent

will be approved by the US patent oce. Anders and Michael have also formed a start-up company called

ITNET, and they have started to market their software product. Last month, they presented some of their

ideas to Singular Inc., the dominant player in this growing market, after Singular had signed a condentiality

agreement with ITNET that ITNET's lawyers had prepared.

Yesterday, Singular announced a new software product that seemed suspiciously similar to the one that Anders

and Michael have developed. Anders' rst reaction was to plan to sue Singular immediately. However, Michael

felt that they should wait until they have received notication of their patent, which is still pending before

the U.S. Patent oce. Michael reasoned that their case would be much stronger if they had a patent for their

product.

Suppose that Anders and Michael have a 90% chance of winning a lawsuit against Singular if their patent

application is approved, and that they still have a 60% chance of winning a lawsuit even while their patent

application is pending (because Singular had signed the condentiality agreement). However, if their patent

application is not approved, the chance of winning the lawsuit would drop to 40%. Anders feels that if they

sue Singular immediately, there is a 70% chance that Singular would settle out of court for $400,000 and a

30% chance that Singular would not settle out of court. If they win the lawsuit, their settlement would be $1

million. However, they estimate that the legal costs of going to court would be $100,000.

(a) Structure ITNET's problem of whether or not to sue Singular as a decision tree. Clearly indicate what

are the decisions to be made and what are the uncertain events.

(b) Solve for the optimal decision strategy (You may use the Precision tree software package to solve the

decision tree) . Describe the optimal strategy. What is your recommendation?

5 The art dealer's problem

An art dealer has a client who will buy the masterpiece Rain Delay for $50,000. The dealer can buy the

painting now for $40,000 (making a prot of $10,000). Alternatively, he can wait one day, when the price will

go down to $30,000. The dealer can also wait another day when the price will be $25,000. If the dealer does
2
not buy by that day, then the painting will no longer be available. On each day, there is a
3 chance that the
painting will be sold elsewhere and will no longer be available.

(a) Draw a decision tree representing the dealers decision making process.

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(b) Solve the tree. What is the dealers expected prot? When should he buy the painting?

(c) What is the Expected Value of Information (value the dealer would place on knowing when the item will

be sold)?

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