EXAMPLE

ABC Company is planning to manufacture its own new PC based

system, which intends to be marketed by next year under its own
brand. One particular concern of the company has something to do
with the keyboard that will be used in the system, which will be
having a special feature on function keys.
The following are the different decision alternatives identified by
the management:
a. The company can manufacture its own unique keyboard
b. The company can buy the keyboards from a local manufacturer.
c. The company can buy the keyboards from Japan.

Quantitative Analysis in Business Decision Theory

 continuation…

The payoff table is given below. The profit contribution is in

thousand pesos

Future Sales Level

Alternative Low Moder High
s ate

Manufacturer -30 20 110

Buy from 20 60 50
local
Buy from 10 45 80
Japan
Quantitative Analysis in Business Decision Theory
 Decision Theory

Jonecis A. Dayap
University of San Jose-Recoletos

Quantitative Analysis in Business Decision Theory

 OUTLI
NE
Introduction

Decision - Making

Decision Environments

Expected Value of Perfect

Information

Decision Tree Analysis

Quantitative Analysis in Business Decision Theory
 Learning
Objectives
Define decision and apply the steps in
decision– making.
Identify the different decision
environments.
Solve decision-making under certainty,
uncertainty and risk.

Quantitative Analysis in Business Decision Theory

 INTRODUCTI
ON

In business, managers always make decision to ensure

the efficient and effective operation of the business.

Examples of business problems that demand decision :

1. What marketing strategy to utilize?

2. How many sales representatives to hire?
3. What selling price to impose on the product?

Remark: Decision makers should make careful evaluation of the different

alternatives and select the best alternative that would meet the requirement on
solving the problem based on the criteria and in accordance with the
organization’s objective .
Quantitative Analysis in Business Decision Theory
 Decision -
Making
 It is an act of selecting a preferred course of
action among alternatives.

Quantitative Analysis in Business Decision Theory

 Decision
Environments

Quantitative Analysis in Business Decision Theory

 1. Maximax

Strategy
The decision maker has to choose the alternative with the
maximum among the maximum payoffs.
 It is also known as the optimistic approach.
Risk – seeker management

Remark: In case the problem is cost minimization, to apply the

preceding strategy, one has to choose the minimum payoff for each
alternative, then finally select the minimum. Thus, this is called
“minimin” for cost.

Quantitative Analysis in Business Decision Theory

 2. Maximin
Strategy
 The decision maker has to choose the alternative with the
maximum among the minimum payoffs.
 It is also known as the pessimistic approach.
Risk averter management

Remark: In case the problem is minimization of cost, to apply the

preceding strategy, one has to select the miximum payoff for each
alternative, then finally choose the minimum. Thus, this is called
“minimax” for cost.

Quantitative Analysis in Business Decision Theory

 3. Laplace
Strategy
 Used to select the alternative with the maximum average payoff.
To compute the value, simply determine the average payoff
for each alternative and then choose the alternative with the
maximum average payoff (profit).

Remark: For cost problem, simply do the same then finally, choose
the alternative with the minimum average payoff.

Quantitative Analysis in Business Decision Theory

 4. Hurwicz Criterion of
Realism
 This strategy is a middle ground criterion between the maximax
and maximin.
The decision maker can assign a value for coefficient or index of
optimism symbolized by the Greek letter α (alpha) with a
value between 0 and 1.
Measure of Realism = α (best payoff) + (1 – α )(worst payoff)

Remark: Choose the maximum value of MR for profit (max MR) and
minimum value of MR for cost (min MR).
Quantitative Analysis in Business Decision Theory
 5. Minimax Regret
Strategy
The decision maker choose the alternative that would minimize
the maximum regret.
To apply this strategy, first determine the regret payoff for each
alternative under each state of nature, then determine the
maximum regret or loss payoff for each alternative, and finally
selecting the minimum among the maximum regrets.
For Profit : Regret value = Highest column entry – every column
entry.
For Cost : Regret value = Every column entry – lowest column
entry.
Quantitative Analysis in Business Decision Theory
 3. Decision Making Under the Condition
of Risk
The decision maker does not know exactly which one among the
different states of nature will occur but can estimate that any
one state will occur.
 To apply this strategy the mathematical expectation(ME) or
expected value (EV) has to be computed by getting the product of
the ( P ) probability of an event and the ( X )amount to be received
upon the occurrence of that event.
 EV = P1(X1) + P2(X2) +…+ Pn(Xn)
The decision maker choose the alternative that has the highest
expected value.
Quantitative Analysis in Business Decision Theory
 EXAMPLE
ABC Company is planning to manufacture its own new PC based
system, which intends to be marketed by next year under its own
brand. One particular concern of the company has something to do
with the keyboard that will be used in the system, which will be
having a special feature on function keys.
The following are the different decision alternatives identified by
the management:
a. The company can manufacture its own unique keyboard
b. The company can buy the keyboards from a local manufacturer.
c. The company can buy the keyboards from Japan.

Quantitative Analysis in Business Decision Theory

 continuation…

The payoff table is given below. The profit contribution is in

thousand pesos

Future Sales Level

Alternative Low Moder High
s ate

Manufacturer -30 20 110

Buy from 20 60 50
local
Buy from 10 45 80
Japan
Quantitative Analysis in Business Decision Theory
 1. Decision making under the condition
of certainty

If the management is certain that the

condition of economy is LOW, the best
decision is to buy from local manufacturer.
If the condition of economy is MODERATE,

the best decision is to buy from local

manufacturer.
If the condition of the economy is HIGH, the

best decision is to manufacture.

Quantitative Analysis in Business Decision Theory

 2. Decision making under the condition of uncertainty

a. Applying the Maximax Strategy

Future Sales Level
Alternative Low Modera High
s te

Manufacturer -30 20 110

Buy from 20 60 50
local
Decision : Since the maximum among the three maximum values refers to
the Buy from of manufacture,
alternative 10 45
therefore 80
ABC Company will
manufacture its own unique keyboard
Japan
Quantitative Analysis in Business Decision Theory
 2. Decision making under the condition of uncertainty

b. Applying the Maximin Strategy

Future Sales Level
Alternative Low Modera High
s te

Manufacturer -30 20 110

Buy from 20 60 50
local
Decision : Since the maximum among the minimum
Buy from
payoffs 10 decision45on buying 80
refers to the from local
suppliers,
Japan therefore ABC Company will buy the
keyboards from local suppliers.

Quantitative Analysis in Business Decision Theory

 2. Decision making under the condition of uncertainty

c. Applying Laplace Strategy

Alternatives Future Sales Level
Low Moderate High
Manufacturer -30 20 110
Buy from local 20 60 50
Buy from Japan 10 45 80

Alternatives Row Total Row Average

Manufacture 100 33.33
Buy from local 130 43.33
Buy from Japan 135 45.00

Decision : The maximum average refers to the third

alternative, which is to buy the units from Japan.
Quantitative Analysis in Business Decision Theory
 2. Decision making under the condition of uncertainty

d. Applying Hurwicz Strategy with α = 60% as a

coefficient of realism:
Alternative Futur Sales Level
s e Moderate High
Low
Manufacture -30 20 110
r
Buy from 20 60 50
local
Manufacture = (0.60)(110) + (0.40)(-30) = 54
Buy from
Buy from local 10 45
= (0.60)(60) 80
+ (0.40)(20) = 44
Japan
Buy from Japan = (0.60)(80) + (0.40)(10) = 52

Decision : The best alternative is to

manufacture
Quantitative Analysis in Business Decision Theory
 2. Decision making under the condition of uncertainty

e. Applying the Minimax Regret

Strategy
Alternatives Future Sales Level
Low Moderat High
e
Manufacturer -30 20 110
Buy from local 20 60 50
Buy from Japan 10 45 80
Alternative Futu Sales Level Maximum
s re Moder High Regret
Regret
Low ate
Table
Manufacture 50 40 0 50
r
Buy from 0 0 60 60
local
Decision
Buy from
: The minimum regret payoff refers to the
third 10 which
alternative, 15 is to
30buy 30
the units from Japan.
Japan
Quantitative Analysis in Business Decision Theory
 3. Decision making under the condition of risk

Alternatives Future Sales Level

Low Moderate High
Manufacturer -30 20 110
Buy from local 20 60 50
Buy from 10 45 80
Japan
State of Low Moderate High
Nature EV =
Probability 25% 60% 15% P(X)
Manufacture = (0.25)(-30) + (0.60)(20) + (0.15)
(110) = 21.0
Buy from local = (0.25)(20) + (0.60)(60) + (0.15)
(50) = 48.5
Decision : The best alternative is to buy from local
Buy from
supplier Japan =
because (0.25)(10)
it has + (0.60)(45)
the highest expected+ (0.15)
value
(80) = 41.5
Quantitative Analysis in Business Decision Theory
 Problem Set 1.1
1. President Steven Ji of MAC Motors is considering whether or not to
build a manufacturing plant in Cavite City. Upon analyzing the
different associated costs and factors to be considered in his plan, he
was able to make a profit-payoff table as summarized below:
STATES OF ECONOMY
Alternatives Expand Contract Unchanged
(20%) (45%) (35%)
No new plant 200 -30 40
Build small 300 -60 60
plant
Build large
Values 400
are in million -120 80
plant the best alternative using the different strategies
Determine
pesos.
below:
a. Maximax f. Expected Value Criterion
b. Maximin
c. Laplace
d. Hurwicz ( α = 0.40)
Quantitative Analysis Regret
e. Minimax in Business Decision Theory
 Assignment 1.1
Cost Payoff Matrix
Investme Possible Inflation Rates Next
nt Year
Alternativ 5% 10% 15%
es

Stocks 120,000 100,000 90,000

Gold 70,000 100,000 140,000
Determine the best alternative using the different strategies
Business
below: 80,000 90,000 100,000
a. Minimin f. Expected Value Criterion
Probability
b. Minimax 0.2 0.5 0.3
c. Laplace
d. Hurwicz ( α = 0.40)
e. Minimax Regret
Quantitative Analysis in Business Decision Theory
Assignment 1.2

Zed and Adrian run a small bicycle shop called "Z to A Bicycles". They
must order bicycles for the coming season. Orders for the bicycles must be
placed in quantities of twenty (20). The cost per bicycle is $70 if they
order 20, $67 if they order 40, $65 if they order 60 and $64 if they order
80. The bicycles will be sold for $100 each. Any bicycles left over at the
end of the season can be sold (for certain) at $45 each. If Zed and Adrian
run out of bicycles during the season, then they will suffer a loss of
"goodwill" among their customers. They estimate this goodwill loss to be
$5 per customer who was unable to buy a bicycle. Zed and Adrian
estimate that the demand for bicycles this season will be 10, 30, 50, or 70
bicycles with probabilities of 0.2, 0.4, 0.3, and 0.1 respectively.
a) Construct a payoff table for this problem.
b) What course of action would you recommend using each of
the following strategies ( Maximax, Maximin, Laplace ,
Minimax Regret and Expected Value Method ) ?
Activity 1
Finicky's Jewelers sells watches for $50 each. During the next month, they
estimate that they will sell 15, 25, 35, or 45 watches with respective
probabilities of 0.35, 0.25, 0.20, and ... (figure it out). They can only buy
watches in lots of ten from their dealer. 10, 20, 30, 40, and 50 watches cost
$40, 39, 37, 36, and 34 per watch respectively. Every month, Finicky's has
a clearance sale and will get rid of any unsold watches for $24 (watches
are only in style for a month and so they have to buy the latest model each
month). Any customer that comes in during the month to buy a watch, but
is unable to, costs Finicky's $6 in lost goodwill.
a) Construct a payoff table for this problem.
b) What course of action would you recommend using each of
the following strategies (Maximax, Maximin, Laplace,
Minimax Regret and Expected Value Method ) ?
 OUTLI
NE
Expected Value of Perfect
Information

Decision Tree Analysis

Quantitative Analysis in Business Decision Theory

 Expected Value of Perfect Information ( EVPI )
 If the managers are able to determine which among the states of
nature will occur, definitely, they know which decision will be the best
for the company
 Expected Value of Perfect Information ( EVPI ) is the price that
one would be willing to pay in order to gain access to perfect
information .
Perfect information – All consumers and producers know all prices
of products and utilities each person would get from owning
each product.
The payoff increases as we determine the certainty of a particular
expected value of perfect information.

Quantitative Analysis in Business Decision Theory

 Method 1
Take the difference between the expected payoff under certainty and
the expected payoff under condition of risk.

Steps :
1. Multiply the best payoff under each state of nature to its
probability.
2. Get the sum of these combined weights.
3. Subtract the highest payoff of the result in decision-making
under the condition of risk from the sum of the combined
weights.
4. The difference is the value of perfect information.

EVPI = Expected Value under Certainty – Maximum EV under Risk

Quantitative Analysis in Business Decision Theory

 Method 1

Alternatives Low Moderat High

e
Manufacturer -30 20 110
Buy from 20 60 50
local
Buy
Statefrom
of Low10 45
Moderat High80
Japan
Nature e
Probability 25% = ( 20 60%
EV under certainty x 0.25 ) + (15%
60 x 0.60 )
+ ( 110 x 0.15 )
= 57.5
MEV under risk = 48. 5
EVPI = EV under certainty - MEV under risk
= 57.5 – 48.5
= 9.0
Quantitative Analysis in Business Decision Theory
 Method 2
Find the expected regret value for each alternative then EVPI is the
smallest expected value..

Steps :
1. Construct Regret Table.
2. Multiply each entry by the probability value of each state of
nature of every alternative
3. Get the sum of these combined weights.
3. The lowest expected value is EVPI

Quantitative Analysis in Business Decision Theory

 Method 2
Alternatives Low Moderat High
e
Manufacturer -30 20 110
Buy from 20 60 50
local
State
Buy fromof Low10 Moderat
45 High
80
Nature
Japan e
Probability 25% 60% 15%
Regret
Table
Alternatives Low Modera High Maximu
te m
Regret
Manufacturer 50 40 0 50
Buy from 0 0 60 60
local Analysis in Business
Quantitative Decision Theory
 Method 2
State of Low Moderat High
Nature e
Probability 25% 60% 15%
Regret
Table
Alternatives Low Modera High Maximu
te m
Regret
Manufacturer 50 40 0 50
Buy from 0 0 60 60
local
Solution
Buy from : 10 15 30 30
Japan
1. Manufacture 50(0.25) + 40(0.60) + 0(0.15) =
36.5
2. Buy from local 0(0.25) + 0(0.60) + 60(0.15) =
9.0
 Example
The management of the RDM Company must decide if they are going to
give their workers a wage increase or not. The company will reduce its
annual profits once they have decided to give an increase to their workers
and it will avoid a possible strike. However, if the management choose not
to give the increase to their annual profits. The possible annual profit is
determined by the economy. If the company will experience a favorable
economy, it will give them a good profit ; if the company will experience
an unfavorable economy, it will make little or no profit at all. The
expected payoff in millions of pesos is given below.
Alternatives Favorabl Unfavorabl
e e
Give the wage 200 0
increase
Do not give the wage 300 100
If favorable economy has a probability of 65%,
increase
determine the ff:
1. EV of each alternative
2. EVPI
Quantitative Analysis in Business Decision Theory
 Decision Tree Analysis

Quantitative Analysis in Business Decision Theory

 Example
Owel is planning to open up a new branch of Engrande Lechon at a new
location in Pasig or expand the existing branch located in Marikina City.
Demand on the new location is expected to be 60% high and 40% low. Fixed
cost will reach the amount of Php 150,000. If the demand becomes high , he
expects to have a revenue of Php 250,000, however if the demand becomes low,
he could only expect a revenue of Php 200,000. Upon analyzing the situation in
his existing branch, he believes that by introducing new recipes the sales will
reach the amount of Php 120,000 if the demand becomes high. However, if the
demand becomes low, he could only expect Php 80,000 revenue. Projection on
high demand in the existing branch tends to be 55% and upon computing the
fixed cost it would reach the amount of Php 50,000. If you were the consultant
of Owel, what would you advise?
 Solution
Information Table for Owel’s Decision
Situation
States of
Alternativ Nature
es
Revenue Expense
s
Probability
High Low High Low

Open a
new 60% 40% Php Php Php
branch
250,000 200,000 150,000
Expand
the 55% 45% Php Php Php
existing
branch
120,000 80,000 50,000
 continuation
Solution
Decision Tree …
Diagram
P(High)= R=
60% 250,000
100,000 E=
a 150,000
80,0
n
p e 00
O w ch P( Low ) =
R=
Open ne an 40%
br
200,000
50,000
/ E=
150,000
Expa
nd P(High)= R=
nd p a

55% 120,000
Ex

70,000 E=
i
ex e
ng ist

52,0 50,000
th

c
h an

00
br

P(Low)= R=
45% 80,000
30,000
E=
50,000
Example
Consider a situation in which the management of RST
Company must decide in choosing an ideal location to open a
new branch of computer shop. The table below shows the
different costs to operate the business in different locations and
the probabilities on sales events.
Locations Low Moderate High
Cubao Php 75,000 Php 85,000 Php150,000

Gilmore Php Php Php

100,000 120,000 150,000
Makati Php Php170,000 Php200,000
150,000
Probability 0.30 0.50 0.20
 Problem Set 1.2
1. A physician is involved in Ph2 million malpractice suit. He can
either settle out of court for Php500,000 or go to the court. If he
goes to the court and loses, he must pay the amount of
Php1,750,000 with the additional of Php250,000 for court costs. If
he wins in the court, the plaintiff will be the one to pay the court
costs.
a. Construct a payoff table for this problem.
b. Consider the physician’s lawyer estimates that the probability of
winning is 0.30. Draw a decision tree and determine the best
solution.

Quantitative Analysis in Business Decision Theory

 References:
Arao, Rosalia R., et.al.(2009). Quantitative Approaches in
Decision-making with Computer Application. Rex Book
Store.
Anderson, D. R., Sweeney, D. J., Williams, T. A., Camm, J.
D., & Cochran, J. J. (2018). An Introduction to
Management Science: Quantitative Approach.
Cengage learning.

Quantitative Analysis in Business Decision Theory

 THANK YOU!!!

Quantitative Analysis in Business Decision Theory