A - 1 2011 Pearson Education, Inc.

publishing as Prentice Hall

A
Decision-Making
Tools
PowerPoint presentation to accompany
Heizer and Render
Operations Management, 10e
Principles of Operations Management, 8e

PowerPoint slides by Jeff Heyl
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2011 Pearson Education, Inc. publishing as Prentice Hall
Example
Table A.1
State of Nature
Alternatives Favorable Market Unfavorable Market
Construct large plant $200,000 $180,000
Construct small plant $100,000 $ 20,000
Do nothing $ 0 $ 0
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DM under Uncertainty
1. If Optimistic (F), choice is a large plant
2. If Pessimistic (UF), choice is to do nothing
Maximax Maximin
Equally
likely
States of Nature
Favorable Unfavorable Maximum Minimum Row
Alternatives Market Market in Row in Row Average
Construct
large plant $200,000 -$180,000 $200,000 -$180,000 $10,000
Construct
small plant $100,000 -$20,000 $100,000 -$20,000 $40,000
Do nothing $0 $0 $0 $0 $0
Not a sound business decision!
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DM Under Risk (Probability)?
Each possible state of nature has an
assumed probability
Probabilities must sum to 1
Determine the expected monetary value
(EMV) for each alternative
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DM Under Risk
1. EMV(A
1
) = (.5)($200,000) + (.5)(-$180,000) = $10,000
Table A.3
States of Nature
Favorable Unfavorable
Alternatives Market Market
Construct large plant (A
1
) $200,000 -$180,000
Construct small plant (A
2
) $100,000 -$20,000
Do nothing (A
3
) $0 $0
Probabilities .50 .50
Best Option
2. EMV(A
2
) = (.5)($100,000) + (.5)(-$20,000) = $40,000
3. EMV(A
3
) = (.5)($0) + (.5)($0) = $0
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EVwPI Example
1. The best outcome for the state of nature
favorable market is build a large
facility with a payoff of $200,000. The
best outcome for unfavorable is do
nothing with a payoff of $0.
Expected value
with perfect
information
= ($200,000)(.50) + ($0)(.50) = $100,000
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DM under Certainty
More certain about the payoff for each
market
Is the cost of perfect information worth it?
Determine the expected value of perfect
information (EVPI)

EVPI is the difference between the payoff
under certainty and the payoff under risk
EVPI =
Expected value
with perfect
information
Maximum
EMV
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Expected Value of
Perfect Information
Expected value with
perfect information
(EVwPI)
= (Best outcome or consequence for 1
st
state
of nature) x (Probability of 1
st
state of nature)
+ Best outcome for 2
nd
state of nature)
x (Probability of 2
nd
state of nature)
+ + Best outcome for last state of nature)
x (Probability of last state of nature)
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2011 Pearson Education, Inc. publishing as Prentice Hall
EVPI Example
2. The maximum EMV is $40,000, which is
the expected outcome without perfect
information. Thus:
= $100,000 $40,000 = $60,000
EVPI = EVwPI
Maximum
EMV
The most the company should pay for
perfect information is $60,000
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Decision Tree Example
Favorable market
Unfavorable market
Favorable market
Unfavorable market
Construct
small plant
A decision node A state of nature node
Figure A.1
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Decision Tree Example
= (.5)($200,000) + (.5)(-$180,000)
EMV for node 1
= $10,000
EMV for node 2
= $40,000
= (.5)($100,000) + (.5)(-$20,000)
Payoffs
$200,000
-$180,000
$100,000
-$20,000
$0
Construct
small plant
Favorable market (.5)
Unfavorable market (.5)
1
Favorable market (.5)
Unfavorable market (.5)
2
Figure A.2
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Complex Decision Tree
Example (Example 7)
Figure A.3
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Complex Example
1. Given favorable survey results
EMV(2) = (.78)($190,000) + (.22)(-$190,000) = $106,400
EMV(3) = (.78)($90,000) + (.22)(-$30,000) = $63,600
The EMV for no plant = -$10,000 so,
if the survey results are favorable,
build the large plant
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Complex Example
2. Given negative survey results
EMV(4) = (.27)($190,000) + (.73)(-$190,000) = -$87,400
EMV(5) = (.27)($90,000) + (.73)(-$30,000) = $2,400
The EMV for no plant = -$10,000 so,
if the survey results are negative,
build the small plant
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Complex Example
3. Compute the expected value of the
market survey
EMV(1) = (.45)($106,400) + (.55)($2,400) = $49,200
The EMV for no plant = $0 so, given
no survey, build the small plant
4. If the market survey is not conducted
EMV(6) = (.5)($200,000) + (.5)(-$180,000) = $10,000
EMV(7) = (.5)($100,000) + (.5)(-$20,000) = $40,000
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Decision Trees
Information in decision tables can be
displayed as decision trees
A decision tree is a graphic display of the
decision process that indicates decision
alternatives, states of nature and their
respective probabilities, and payoffs for
each combination of decision alternative
and state of nature
Appropriate for showing sequential
decisions
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