DECISION

ANALYSIS
Cenidoza, Dominic Ian
Dy Bunting, Joanne
Espartero, Meriella
Leynes, Kathleen
Mandap, Ernestine
Panopio, Jonah
Reyes, Alexa Jane
Soriano, Aldrich Mico

DECISION
MAKING
PROCESS
Jonah Panopio

Decision

making is the study of

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

Making

a decision implies that there

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

According

to Baker et al. (2001),

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

6 STEPS IN
DECISION
MAKING
Dominic Cenidoza

6 Steps in Decision
Making

1. Clearly define the problem at hand.

2. List the possible alternatives.
3. Identify the possible outcomes or
states of nature.
4. List the payoff (typically profit) of
each combination of alternatives and
outcomes.
5. Select one of the mathematical
decision theory models.
6. Apply the model and make your

Sample Case: Thompson

Lumber Co.
Step

1: Defining the problem

The problem that John Thompson

identifies is whether to expand
his product line by
manufacturing and marketing a
new product, backyard storage
sheds.

Sample Case: Thompson

Lumber Co.
Step

2: Listing Possible Alternatives

*Alternative - a course of action or a

strategy that the decision maker can
choose
Alternatives:
(1) Construct a large new plant to
manufacture the storage sheds
(2) Construct a small plant
(3) no plant at all

Sample Case: Thompson

Lumber Co.
Step

3: Identify Possible
Outcomes

Possible Outcomes:
(1) Favorable Market (high
demand for the product)
(2) Unfavorable Market (low
demand for the product)

Sample Case: Thompson

Lumber Co.
Step

4: Listing Payoffs of Each

Alternative
*Conditional Values - payoffs or
profits of the outcomes
Because Thompson wants to
maximize his profits, he can use
profit to evaluate each
consequence.

Sample Case: Thompson

Lumber Co.

Sample Case: Thompson

Lumber Co.
Step

5: Selecting the Decision

Theory Model
Depends on Decision Making
Environment

Step

6: Applying the Model to

make the Decision

Decision Theory
Alexa Jane Reyes

Decision Theory

Decision theory is an
analytic and systematic
approach to the study of
decision making.

Decision Theory
It is a framework of logical and
mathematical concepts, aimed
at
helping
managers
in
formulating rules that may
lead to a most advantageous
course of action under the
given circumstances.

Decision Theory
Decision
theory
divides
decisions into three classes:
1. Decisions under certainty
2. Decisions under conflict
3. Decisions
under
uncertainty

DECISION
TABLES
Aldrich Mico M. Soriano

What is a decision table?

It

can be a useful way to represent

and analyze a scenario where there is
a range of possible outcomes and a
variety of possible responses.

Also
It

called as payoff table

simply illustrates all possible

profits/losses and as such is often used
in decison making under uncertainty.

Making a Decision Table

Consider

the following:
Alternatives
Possible outcomes
Payoffs

EXAMPLE 1.0

EXAMPLE 2.0 - Making a

Decision Table
You are a marketing manager for a food products
company, considering the introduction of a new brand of
organic salad dressings. You need to develop a marketing
plan for the salad dressings in which you must decide
whether you will have a gradual introduction of the salad
dressings (with only a few different salad dressings
introduced to the market) or a concentrated introduction
of the salad dressings (in which a full line of salad
dressings will be introduced to the market). You estimate
that if there is a low demand for the salad dressings, your
first years profit will be $1 million for a gradual
introduction and - $5 million (a loss of $5 million) for a
concentrated introduction. If there is high demand, you
estimate that your first years profit will be $4 million for a
gradual introduction and $10 million for a concentrated

EXAMPLE - Making a
Decision Table

Types of DecisionMaking Environments

1. Decision

making under

certainty
2. Decision making under
uncertainty
3. Decision making under risk

Decision Making Under

Uncertainty
1. Optimistic

(Maximax)

2. Pessimistic
3. Criterion
4. Equally

(Maximin)

of Realism (Hurwicz)

Likely (Laplace)

5. Minimax

Regret

Decision Making Under

Uncertainty
Optimistic (Maximax)

The best (maximum) payoff for

each alternative is considered
The alternative with the best
(maximum) of these is selected

Decision Making Under

Uncertainty

Decision Making Under

Uncertainty
Pessimistic (Maximin)

The worst (minimum) payoff for

each alternative is considered
and
The alternative with the best
(maximum) of these is selected.

Decision Making Under

Uncertainty

Criterion of Realism
(Hurwicz Criterion)
Often called the weighted average,
A coefficient of realism =
This coefficient is between 0 and 1.
The weighted average is computed as
follows:
Weighted Average = (maximum in
row) + (1 )(minimum in row)
Compute for the weighted averages for
each alternative
Select the alternative with the highest

Criterion Realism

Equally Likely (Laplace)

Considers all the payoffs for each
alternative
Find the average payoff for each alternative
Select the alternative with the highest

average

ALTERNATIVE

STATE OF NATURE
FAVORABLE
MARKET ($)

UNFAVORABLE
MARKET ($)

ROW
AVERAGE ($)

Construct a large
plant

200,000

180,000

10,000

Construct a small
plant

100,000

20,000

40,000

Do nothing

Table 3.5

Equally likely
0

Minimax Regret
Based on opportunity loss or
regret, the difference between the
optimal profit and actual payoff for a
decision
Create an opportunity loss table by
determining the opportunity loss for
not choosing the best alternative
Opportunity loss is calculated by
subtracting each payoff in the column
from the best payoff in the column
Find the maximum opportunity loss for
each
alternative
and
pick
the

Minimax Regret
STATE OF NATURE

Opportunity
Loss Tables

FAVORABLE
MARKET ($)

UNFAVORABLE
MARKET ($)

200,000 200,000

0 (180,000)

200,000 100,000

0 (20,000)

200,000 0

00
Table 3.6

STATE OF NATURE
ALTERNATIVE

FAVORABLE
MARKET ($)

UNFAVORABLE
MARKET ($)

Construct a large plant

180,000

Construct a small plant

100,000

20,000

Do nothing

200,000

Table 3.7

Minimax Regret
STATE OF NATURE
ALTERNATIVE

FAVORABLE
MARKET ($)

UNFAVORABLE
MARKET ($)

MAXIMUM IN
A ROW ($)

Construct a large
plant

180,000

180,000

Construct a small
plant

100,000

20,000

100,000

Do nothing

200,000

Table 3.8

Minimax

200,000

In-Class Example 1:
Minimax Regret Opportunity
Loss Table
Alternative
Construct a
large plant
Construct a
small plant
Do nothing

State of Nature
Good Average
Poor
Market Market Market
($)
($)
($)

Maximum
Opp.
Loss

25,000

10,000

40,000

40,000

60,000

60,000

100,000

35,000

100,000

In-Class Example 1: Equally Likely

Alternative
Construct a
large plant
Construct a
small plant
Do nothing

State of Nature
Good Average
Poor
Market
Market
Market
($)
($)
($)

Avg

25,000

8,333

-13,333

20,000

33,333

11,665

-20,000

25,000

Decision Making Under Risk

A

situation in which several possible

states of nature may occur, and the
probabilities of these states of nature
are known.

Most

popular method: selecting the

alternative with the highest expected
monetary value (EMV)

EMV

long-run average value of that

decision

Expected Monetary Value

EMV (alternative) = P()

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

EMV (alternative i)= (payoff of first state of nature) x

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

EMV for Thompson Lumber

Each

market has a probability of 0.50

EMV (large plant) = (0.50)($200,000) +
(0.50)($180,000)
= $10,000
EMV (small plant)= (0.50)($100,000) +
(0.50)($20,000)
= $40,000
EMV (do nothing) = (0.50)($0) + (0.50)($0)
= $0

EMV for Thompson Lumber

STATE OF NATURE
ALTERNATIVE

FAVORABLE
MARKET ($)

UNFAVORABLE
MARKET ($)

EMV ($)

Construct a large
plant

200,000

180,000

10,000

Construct a small
plant

100,000

20,000

40,000

Do nothing

Probabilities

0.50

0.50

Largest EMV
NOTE: When using the EMV criterion with minimization
problems the calculations are the same but the alternative with
the smallest EMV is selected.

DECISION TREES
Ernestine Mandap

Decision Trees
Any

problem that can be presented in

a decision table can also be
graphically represented in a decision
tree

Decision

trees are most beneficial

when a sequence of decisions must be
made

All

decision trees contain decision

points or nodes and state-ofnature points or nodes

Five Steps to Decision

Tree Analysis
1. Define

the problem

2. Structure

or draw the decision tree

3. Assign

probabilities to the states

of nature

4. Estimate

payoffs for each possible

combination of alternatives and
states of nature

5. Solve

the problem by computing

expected monetary values (EMVs)

Structure of Decision Trees

Trees

start from left to right

Represent

decisions
sequential order

and

outcomes

Squares

represent decision nodes

Circles

represent

states

of

in

nature

nodes
Lines

or branches connect the decisions

nodes and the states of nature

Thompsons Decision Tree

A State-of-Nature Node
Favorable Market

A Decision Node

ct
u
r
t
ns e
o
C arg t
L lan
P

Favorable Market

Construct
Small Plant
Do

Figure 3.2

Unfavorable Market

No
th
in
g

Unfavorable Market

Structure of Decision Trees

All possible outcomes and

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

Thompsons Decision Tree

EMV for Node
1 = $10,000

= (0.5)($200,000) + (0.5)($180,000)
Favorable Market(0.5)

Alternative with best

EMV is selected
c
ru
t
ns ge
o
C Lar t
t lan
P
Construct
Small
Do
Plant
No
th
in
g

Unfavorable Market(0.5)

Favorable Market(0.5)

Unfavorable Market(0.5)

EMV for Node

2 = $40,000

Payoffs
$200,000
$180,000

$100,000
$20,000

= (0.5)($100,000)
+ (0.5)($20,000)
Figure 3.3

$0

Thompsons Complex Decision Tree

Using Sample Information
Thompson

Lumber has two decisions two

make, with the second decision dependent
upon the outcome of the first
First, whether or not to conduct their own
marketing survey, at a cost of $10,000, to
help them decide which alternative to
pursue (large, small or no plant)

The survey
information

does

not

provide

perfect

Then, to decide which type of plant to

build

Note that the $10,000 cost was subtracted

Thompsons Complex Decision

Tree

)
45
.
(0
y ts e
e
rv ul abl
Su Res or
v
1 Sur Fa
ve
Re y (
Ne su 0.5
5)
ga lts
tiv
e

nt
Pla
e
g
Lar
Small
Plant

2
3

Unfavorable Market (0.22)

Favorable Market (0.78)
Unfavorable Market (0.22)
No Plant
Favorable Market (0.27)

nt
Pla
e
g
Lar
Small
Plant

4
5

du
ct

M
ar
ke

tS
ur
ve
y

Favorable Market (0.78)

Unfavorable Market (0.73)

Favorable Market (0.27)
Unfavorable Market (0.73)

Co
n

No Plant

Do
Not
Con
duc

Favorable Market (0.50)

t Su
rve

t
lan
P
ge
Lar
Small
Plant

6
7

Unfavorable Market (0.50)

Favorable Market (0.50)
Unfavorable Market (0.50)
No Plant

1.

Thompsons Complex
Decision
Tree
Given favorable survey results
(market favorable for sheds),
EMV(node 2)

= EMV(large plant | positive survey)

= (0.78)($190,000) + (0.22)($190,000) = $106,400

EMV(node 3)

= EMV(small plant | positive survey)

= (0.78)($90,000) + (0.22)($30,000) = $63,600

EMV for no plant = $10,000
2. Given negative survey results,
EMV(node 4)

= EMV(large plant | negative survey)

= (0.27)($190,000) + (0.73)($190,000) = $87,400

EMV(node 5)

= EMV(small plant | negative survey)

= (0.27)($90,000) + (0.73)($30,000) = $2,400

EMV for no plant = $10,000

Thompsons Complex
Decision Tree

pute the expected value of the market survey,

node 1) = EMV(conduct survey)
(0.45)($106,400) + (0.55)($2,400)
$47,880 + $1,320 = $49,200
market survey is not conducted,
node 6) = EMV(large plant)
(0.50)($200,000) + (0.50)($180,000) = $10,000
node 7) = EMV(small plant)
(0.50)($100,000) + (0.50)($20,000) = $40,000
or no plant = $0
choice is to seek marketing information

Thompsons Complex Decision

Tree
Figure 3.4
First Decision
Point

Payoffs

Second Decision
Point

$49,200

$106,400

$106,400 Favorable Market (0.78)

Small
Plant

$63,600

$190,000
Unfavorable Market (0.22)
$190,000
Favorable Market (0.78)
$90,000
Unfavorable Market (0.22)
$30,000

No Plant
$87,400 Favorable Market (0.27)

Small
Plant

$2,400

$10,000

$40,000

Favorable Market (0.27)

Unfavorable Market (0.73)
No Plant

$49,200

$2,400

Unfavorable Market (0.73)

Favorable Market (0.50)

Unfavorable Market (0.50)

Small
Plant

$40,000

Favorable Market (0.50)

Unfavorable Market (0.50)
No Plant

$10,000
$190,000
$190,000
$90,000
$30,000
$10,000

$200,000
$180,000
$100,000
$20,000
$0

Complex Decision
Tree

Example Marys
Factory

Mary is a manager of a gadget factory. She is

wondering whether or not it is a good idea to
expand her factory this year. The cost to expand
her factory is $1.5M. If she does nothing and the
economy stays good and people continue to buy
lots of gadgets, she expects 3M revenue; while
only 1M if the economy is bad.
If she expands the factory, she expects to receive
$6M if the economy is good and $2M if the
economy is bad.
She also assumes that there is a 40% chance of
good economy and 60% chance of bad economy.

Example Marys
Factory
Cost - $1.5M

Good economy (40%)

$6M

Bad economy (60%)

$2M

Good economy (40%)

$3M

Expand

Do not
expand

Cost - $0

Bad economy (60%)

$1M

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

1.5M = $2.1M
EMVnot expand = [(0.4 x 3M) + (0.6 x 1M)]
= $1.8M

Example Joes Garage

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

Example Joes Garage

Cost Hire
$50,000

Increase in
accidents (70%)
Fewer accidents (30%)

Do not
hire

$70,0
00
$20,000

Cost - $0

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

50,000 = -$7,000
Therefore, Joe should not hire the
mechanic.