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14.

Decision Making Under Certainty-Analytic Hierarchy Process (AHP)

structed: Cell reference to the alternative UA must be column-fixed (namely, $L8 and $N8), whereas all other references must be row-and-column-fixed (namely, $L$4 and $L$5). The validity of the formulas requires that the (column-fixed) alternatives' weights of each matrix appear in the same column with no intervening empty cells.For example, in Figure 14.3, the three AR-weights in column L cannot be broken between two columns. The same applies to the AL-weights in column N. On the other hand, there are no restrictions on the placement of the A-weights because-they are raw-and column-fixed in the formula. You can embellish the formula to capture the names of the alternatives directly. Here is how the formula for alternative UA should be entered:
=$K8&"="&TEXT($L$4*$L8+$L$5*$N8, "####0.00000")

Note that the names of the alternatives are stored in K8:K10. It is your responsibility to make sure that these cells contain the names of the alternatives. The procedure for evaluating alternatives can be extended readily to any number of hierarchy levels. Once you develop the formula correctly for the first alternative, the same formula is applicable to the remaining alternatives simply by copying it into (same column) succeeding rows. Just remember that all cell references in the formula must be row-and-column-fixed, except for references to the alternatives, which must be column-fixed only.Problem 1, Set 1 4.1b asks you to develop the formula for a three level problem.
PROBLEM SET 14.182
1. Consider the data of Problem 1, Set 14.1a. Copy the weights logically into the solution
summary section of the spreadsheet ch14AHP.xls, and then develop the formula for eval

uating the first alternative, UA, and copy it to evaluate the remaining two alternatives.

2. The personnel department at C&H has narrowed the search for a prospective employee
to three candidates: Steve uses matrix three criteria: personal interview

(S), Jane (f), and Maisa (M). The final selection is based on (I), experience (E), and references (R). The department

A (given below) to establish the preferences among the three criteria. After Ab A, and AR are constructed. Which of the three candidates

interviewing the three candidates and compiling the data regarding their experiences and references, the matrices should be hired? Assess the consistency of the data.

1 (l l) ( A=! ) ( ) t l)
I
E

R
)

J M
3 1

2 5

A,

' '

Ml 4

5
1

s 1 A= J 3 M! 2

J M ! 2 3
1

J M 1 2
2

AR = f 2
M1

2You are encouraged to use spreadsheet ch14AHPxls to verify your calculations.

14.2

Decision Making Under Risk

51

to represent the two alternatives of investing in stocks A or B. Next, the two branches emanating from chance events 2 and 3 represent the "bull" and the "bear" markets with their respective probabilities and payoffs. From Figure 1 4.3, the expected 1-year returns for the two alternatives are For stock A For stock B
=

$5000 $1500

X x

.6 .6

+ +

( - 2000) $500
x

.4 = $2,200
=

.4

$1,100

Based on these computations, your decision is to invest in stock A._ In the terminology of decision theory, the "bull" and the "bear" markets in the preceding example are referred to as states of nature, whose chances of occurrence are probabilistic (.6 versus .4). In general, a decision problem may include n states of nature and m alternatives. If p1 (> 0) is the probability of occurrence for state of nature j and a;1 is the payoff of alternative i given state of nature j (i 1, 2, . .. , m; j 1, 2, .. . , n), then the expected payoff for alternative i is computed as
= =

EV;

a;1p1

a;2p2

+ ... +

a;nPm i

1, 2, ... ,
=

By definition, p1 + P2 + . . + Pn = 1. The best alternative is the one associated with EV: max,{EV;} or EV: min;{EV;} depending, respectively, on whether the payoff of the problem represents profit (income) or loss (expense).
=

PROBLEM SET 14.2A


1.

You have been invited to play the Fortune Wheel game on television.The wheel operates electronically with two buttons that produce hard (H) or soft (S) spin of the wheel.The wheel itself is divided into white (W) and red (R) half-circle regions. You have been told that the wheel is designed to stop with a probability of .3 in the white region and .7 in the red region.The payoff you get for the game is
W H s R

Draw the associated decision tree, and specify a course of action. ,.? 2. Farmer McCoy can plant either corn or soybean. The probabilities that the next harvest prices of these commodities will go up, stay the same, or go down are .25, .30, and .45, respectively. If the prices go up, the corn crop will net $30,000 and the soybean will net $10,000. If the prices remain unchanged, McCoy will (barely) break even. But if the prices go down, the corn and soybean crop will sustain losses of $35,000 and $5000, respectively. (a) Represent McCoy's problem as a decision tree. (b) Which crop should McCoy plant? 3. You have the chance to invest in three mutual funds: utility, aggressive growth, and global.The value of your investment will change depending on the market conditions. There is a 10% chance the market will go down, 50% chance it will remain moderate, and

14.2

Decision Making Under Risk

51---

8.

/'"

9.

(a) Draw the decision tree for the game. (b) Do you ever come out ahead in this game? Acme Manufacturing produces lots of widget with .8%, 1%, 1.2%, and 1.4% defectives according to the respective probabilities .4, .3, .25, and .05. Three customers-A, B, and C-are contracted to receive batches with no more than .8%, 1.2%, and 1.4% defectives, respectively. Acme will be penalized $1000 per percentage point if the percentage of defectives is higher than specified in the contract. Conversely, supplying higher quality batches than required costs Acme $500 per percentage point.A,ssume that the batches are not inspected before shipment. (a) Draw the associated decision tree. (b) Which of the three customers should have the highest priority to receive their order? TriStar plans to open a new plant in Arkansas. The company can open a full-sized plant now or a small-sized plant that can be expanded 2 years later if high demand conditions prevail.The time horizon for the decision problem is 10 years.TriStar estimates that the probability for high and low demands over the next 10 years is .75 and .25, respectively. The cost of immediate construction of a large plant is $5 million, and a small plant costs $1 million. Expansion of a small plant 2 years from now costs $4.2 million.The income from the operation over the next 10 years is given in the following table:
Estimated annual income (in $1000)

Alternative
Full-sized plant now Small-sized plant now Expanded plant in 2 years

High demand
1000 250 900

Low demand
300 200 200

10.

11.

(a) Develop the associated decision tree, given that after 2 years TriStar has the option to expand or not expand the small plant. (b) Develop a construction strategy for TriStar over the next 10 years. (For simplicity, ignore the time value of money. ) Rework Problem 9, assuming that the annual interest rate is 10% and that the decisions are made considering the time value of money. (Note: You need compound interest tables to solve this problem.) Rework Problem 9, assuming that the demand can be high, medium, and low with proba bilities .7, .2, and .1, respectively. Expansion of a small plant will occur only if demand in the first 2 years is high. The following table gives the annual income. Ignore the time value of money.
Estimated annual income (in $1000)

Alternative
Full-sized plant now Small-sized plant now Expanded plant in 2 years

High demand
1000 400 900

Medium demand
500 280 600

Low demand
300 150 200

12.

Sunray Electric Co-op uses a fleet of 20 trucks to service its electric network.The com pany wants to develop a periodic preventive maintenance for the fleet. The probability of a breakdown in year 1 is zero. For period 2, the breakdown probability is .03, and it