Decison Making and Trees Problems Solutions-Final

Decision Making and Trees Problems Solution
Decision Models
Decision making and trees

problems solution
Prof. M Hamdy Elwany
By
Hesham Anis Baraka
Hesham Baraka – [DBA intake 4] Page 1

Decision Analysis
Exercise Decision Tree

1. A couple has just purchased a Victorian home to remodel into a bed and breakfast. The following table
shows their expected profit ($000s) the first year, depending on how many rooms they choose to remodel
and demand.
Demand
Alternative Low Mod. Heavy
(0.30) (0.50) (0.20)
4 Rooms 15 20 25
8 Rooms 10 35 50
12 Rooms 5 50 75
Using the previous information:

(a) What decision would be made if the maximax criterion is used? What is the value of the decision?
Solution
12 rooms, $75,000
(b) What decision would be made if the maximin criterion is used? What is the value of the decision?
Solution
4 rooms, $15,000
(c) What decision would be made if the minimax regret criterion is used? What is the value of the decision?
Solution
12 rooms, $10,000
(d) What decision would be made if the equal likelihood criterion is used? What is the value of the decision?
Solution
12 rooms, $43,333
(e) What is the expected value of each alternative? What is the best decision?
Solution
4 rooms, $19,500
8 rooms, $30,500
12 rooms, $41,500 Best decision
(f) Draw a decision tree for the problem. Be sure to carefully label the branches of the tree and provide the
value at each node.

.20 High 25
.50
Medium 20
4 Rooms .30
Low 15
19.5
$58,500 .20 High 50

8 Rooms
30.5 .50
Medium 35
.30 Low 10
12 Rooms 75
.20 High
41.5
.50 50
Medium
.30 5
Low

Exercise problems
(1)The material manager of a certain company is trying to determine if his company should purchase a
certain part or produce it in-house. If purchased, it will cost $ 6 per unit. The company can make it for $ 3.50
per unit with a fixed cost of $ 9000 on a high-speed machine. Or it can make it using less automation at a
variable cost of $ 4.50 per unit with a fixed cost of $ 4000. Which alternative should the manager select?
Units Demanded Probability of Demand

7000 0.30
8000 0.45
9000 0.25
Hint: Start by constructing a decision tree, then calculate the expected value of the costs for each end point.

(2) Given the following sequential decision tree, the revenue value of each possibility is shown in the
decision tree. Determine which is the optimal investment, A or B.?
EV Investment A =
= $75000 * 0.70 + 45000 * 0.30 + 60000 * 0.60 + 300000 * 0.40
= 52500+13500+36000+120000
=222,000
EV Investment B =
= 80000 * 0.30 + 55000 * 0.55 + 60000 * 0.15 + 40000 * 0.65 + 105000 * 0.35 +
60000 * 0.15 + 70000 * 0.80 + 200000 * 0.20
=24000+30250+9000+26000+36750+9000+56000+40000
=231,000

(3) Computrade Computer Repair Company is faced with greater demand than its present work force can
handle. It is considering how to expand service. One proposal would add four new repair persons. This
would increase annual fixed operating costs by $ 100,000 for personnel and other related costs such as
equipment. Three new service persons would require an additional $ 80,000 in annual fixed costs, and two
would add $ 60,000.
The variable operating cost per trip would average $ 4.50, and the average revenue per trip is $ 45.00
regardless of adding four, three, or two people. On the average, each worker can make 3.5 trips per day.
Base the calculations on 250 working days per year. Following is the distribution of trips per day that cannot
be satisfied with the present work forces:
Trips per day Probability

5 0.02
6 0.08
7 0.10
8 0.12
9 0.20
10 0.20
11 0.16
12 0.10
13 0.02
1) Determine the value of P:The probability that demand > a given supply (at least one additional unit
is sold)
MP = $45 - $4.5 = $40.5

ML = $0 - $4.5 = $4.5
ML
P 
ML  MP
$4.5

$4.5  $40.5
P  0.10

2) Construct a probability table
Trips per day Probability P*(the probability of sales

this level or greater)
5 0.02 1.00 > 0.1
6 0.08 0.98 > 0.1
7 0.10 0.90 > 0.1
8 0.12 0.80 > 0.1
9 0.20 0.68 > 0.1
10 0.20 0.48 > 0.1
11 0.16 0.28 > 0.1
12 0.10 0.12 > 0.1
13 0.02 0.02 > 0.1
Continue ordering inventory as long as the probability of selling one more unit is greater than or
equal to P
P = .01

(4) A company is introducing a new snowshoe and must decide how much capacity will be needed to
manufacture it. They developed Table showing expected profit for the first year ($000’s).
Alternative Demand
Low (0.3) Moderate (0.5) Heavy (0.2)
Small Plant 40 50 55
Medium Plant 20 75 75
Large Plant 10 60 100
Using the tabulated data:
(a) What alternative would be chosen if the maximax criterion is used? What is the value of the
decision?
Maximax Solution
The maximax criterion (an optimistic approach):
1. For each option, find the maximum profit.
2. Choose the option with the greatest maximum profit.
Investment Profit in $1,000’s Maximu

choice m Profit
)Alternatives ( )States of Nature(
Small plant 40 50 55 55
Medium plant 20 75 75 75
Large plant 10 60 100 100

2. Greatest maximum is to choose large plant

The value of the decision is 100
(b) What decision would be made if the maximin criterion is used? What is the value of the decision?
Maximin Solution
The maximin criterion (a pessimistic approach):
1. for each option, find the minimum profit.
2. Choose the option with the greatest minimum profit.
Investment Profit in Mini

choice s’1,000$ mum
Profit
)Alternatives ( States of(
)Nature

2. Greatest Minimum is to choose Small plant

(c) What decision would be chosen if the minimax regret criterion is used? What is the value of the
decision?
Opportunity Loss
Opportunity loss is the difference between an actual payoff for a decision and the optimal payoff for that
state of nature
Investment choice Profits in $1,000’

(States of
( Alternatives) Nature)
Small plant 40 50 55
Medium plant 20 75 75
Large plant 10 60 100
Opportunity Loss Table

Investment choice Opportunity Loss in $1,000’
(States of
Small plant 0 25 45
Medium plant 20 0 25
Large plant 30 15 0

Minimax Regret Solution

1. For each alternative, find the maximum opportunity loss (or “regret”)
2. Choose the option with the smallest maximum loss
1. Maximum Op. Loss

1.Maximum Op.
Investment choice Opportunity Loss in $1,000’ Loss
(States of
2. Smallest maximum loss is to choose medium plant

(d) What decision would be chosen if the equal likelihood criterion is used? What is the value of the
decision?
Investment Row
average
choice Profits in $1,000’
(States of
Small plant 40 50 55 48.33
Medium plant 20 75 75 56.67
Large plant 10 60 100 56.67

1. Calculate the average payoff for each alternative

Average payoff: the sum of all payoffs divided by the number of states of –
nature
To calculate raw averages:

Small plant = (40 + 50 + 55)/3
=48.33
Medium plant = (20+75+75) /3
= 56.67
Large plant = (10+60+100)/3
= 56.67
2. Select the decision with the highest weighted value

Maximum is 56.67; corresponding decision is to build the medium plant or the large
plant. The value of the decision is 56.67
(e)What is the expected value of the best decision? What is the value of the decision?
Expected Value Solution

Investment choice Profit in $1,000’s Expecte
)Alternatives ( )States of Nature( d Values
DEMAND
Low 0.3 Moderat Heavy 0.2
e 0.5
Medium plant 20 75 75 48.5
EV (Small Plant) = 40 (0.3) + 50 (0.5) + 55 (0.2) = 48

EV (Medium Plant) = 20 (0.3) + 75 (0.5) + 75 (0.2) =48.5
EV (Large Plant) = 10 (0.3) + 60 (0.5) + 100 (0.2) = 53
2. Maximize expected value by choosing large plant


1. Telecomp is a manufacture of cellular telephones. It is planning to build a new manufacturing and

distribution facility in Egypt, Syria, UAE, Kuwait, or Oman. The cost of the facility will differ between
countries and will even vary within countries depending on the economic and political climate, including
monetary exchange rates. The company has established the facility cost (in € millions) in each country
under three different future economic/political climates as follows
Economic/Political Climates
Probability Decline Same Improve
0.30 0.40 0.30
Country
Egypt 21.7 19.1 15.2
Syria 19.0 18.5 17.6
UAE 19.2 17.1 14.9
Kuwait 22.5 16.8 13.8
Oman 25.0 21.2 12.5
Determine the best decision using the following decision criteria.
1. Minimin
2. Minimax
3. Equal likelihood
4. Expected vale
A) The minimin is 12.5 in Oman
Minimum of
each row
Egypt 21.7 19.1 15.2 15.2
Syria 19.0 18.5 17.6 17.6
UAE 19.2 17.1 14.9 14.9
Kuwait 22.5 16.8 13.8 13.8
Oman 25.0 21.2 12.5 12.5
B) The Mini max is 19.0 in Syria
Maximum of
each row
Egypt 21.7 19.1 15.2 21.7
Syria 19.0 18.5 17.6 19.0
UAE 19.2 17.1 14.9 19.2
Kuwait 22.5 16.8 13.8 22.5
Oman 25.0 21.2 12.5 25.0

C) The equal likelihood
Average of
each row
Egypt 21.7 19.1 15.2 18.6
Syria 19.0 18.5 17.6 18.3
UAE 19.2 17.1 14.9 17.06
Kuwait 22.5 16.8 13.8 17.7
Oman 25.0 21.2 12.5 19.56
Select the decision with the highest weighted value

Which are 19.56 in Oman
D) Expected value
0.30 0.40 0.30 EV

Egypt 21.7 19.1 15.2 18.71
Syria 19.0 18.5 17.6 18.38
UAE 19.2 17.1 14.9 16.98
Kuwait 22.5 16.8 13.8 17.61
Oman 25.0 21.2 12.5 19.73
Egypt EV = 21.7 * 0.30 + 19.1 * 0.40 + 15.2 * 0.30 =
= 6.51 + 7.64 + 4.56 = 18.71
Syria EV = 19.0 * 0.30 + 18.5 * 0.40 + 17.6 * 0.30 =
= 5.7 + 7.4 + 5.28 = 18.38
UAE EV = 19.2 * 0.30 + 17.1 * 0.40 + 14.9 * 0.30 =
= 5.67 + 6.84 + 4.47 = 16.98
Kuwait EV = 22.5 * 0.30 + 16.8 * 0.40 + 13.8 * 0.30=
= 6.75 + 6.72 + 4.14 = 17.61
Oman EV = 25 * 0.30 + 21.2 * 0.40 + 12.5 * 0.30 =
= 7.5 + 8.48 + 3.75 = 19.73
Maximize expected value by choosing large plant

The value of the decision is 19.73 in Oman

1. Given the following payoff table with three states of nature and two decisions, as follows:
States of Nature
Decision a b c
Probability 0.65 0.15 0.20
A1 250 100 25
A2 100 100 75
1. What decision would be made using the maximax criterion?

2. What decision would be made using the maximin criterion?
3. What decision would be made using the minimax regret criterion?
4. What is the value of minimax regret?
5. Using the expected value approach to decision making, what is the optimal decision?
6. What is the expected value of A1?
Decision a b c Maximum of each

row
A1 250 100 25 250
A2 100 100 75 100
A1 decision value = 250
Decision a b c Maximum of each

row
A1 250 100 25 250
A2 100 100 75 100
A2 decision value = 100
3. What is the value of minimax regret?
Opportunity loss
Decision a b c 1.Maximum Op.

Loss
A1 0 0 50 50
A2 150 0 0 150
Smallest maximum loss is to choose A1 = 50

4. Using the expected value approach to decision making, what is the optimal decision?
States of Nature
Decision a b c EV
A1 250 100 25 182.5
A2 100 100 75 95
EV = 250 * 0.65 + 100 * 0.15 + 25 * 0.20 = 162.5+15+5=182.5
EV = 100 * 0.65 + 100 * 0.15 + 75 * 0.20 = 65+15+15 = 95

1. Given the following payoff table:

Table 1
Decision Interest rates

5% (0.2) 7%(0.6) 9%(0.2)
Money market 1.7 2.8 4.5
fund
Bond fund -5 4 2
Risk fund 5 -7 3.5
Government fund 4 3.6 9.3
1. What decision would be made using the maximin criterion?
Decision Interest rates Minimum of

each row
5% (0.2) 7%(0.6) 9%(0.2)
Money market 1.7 2.8 4.5 1.7
fund
Bond fund -5 4 2 -5
Risk fund 5 -7 3.5 -7
Government 4 3.6 9.3 3.6
fund
The maxi min is 3.6 government funds
Decision Interest rates Maximum of

each row
5% (0.2) 7%(0.6) 9%(0.2)
Money market 1.7 2.8 4.5 4.5
fund
Bond fund -5 4 2 4
Risk fund 5 -7 3.5 5
Government 4 3.6 9.3 9.3
fund
The maximax is 9.3 government funds

Decision Interest rates

5% (0.2) 7%(0.6) 9%(0.2)
Money market 1.7 2.8 4.5
fund
Bond fund -5 4 2
Risk fund 5 -7 3.5
Government fund 4 3.6 9.3
Decision Interest rates Opportunity loss
5% (0.2) 7%(0.6) 9%(0.2)

Money market 3.3 1.2 4.8 4.8
fund
Bond fund -10 0 7.3 7.3
Risk fund 0 -3 5.8 5.8
Government 1 0.4 0 1
fund
Smallest maximum loss is to choose Government funds = 1
4. What is the expected value without perfect information?
5. What is the expected value with perfect information?
6. What is the expected value payoff of Money market fund?

1. A couple has just purchased a Villa to remodel into a bed and breakfast. Table 2 shows their expected
profit ($000s) the first year, depending on how many rooms they choose to remodel and demand.
Table 2
Alternativ Demand
e Low (.30) Mod. (.50) Heavy
(.20)
4 Rooms 15 20 25
8 Rooms 10 35 50
12 Rooms 5 50 75
1. Using the information in Table 2, what decision would be made if the maximax criterion is used? What
is the value of the decision?
Alternative Demand Maximum of each row

Low (.30) Mod. Heavy
(.5 (.20)
0)
4 Rooms 15 20 25 25
8 Rooms 10 35 50 50
12 Rooms 5 50 75 75
The maximax is to choose 75 which is 12 rooms
2. Using the information in Table 2, what decision would be made if the maximin criterion is used? What is
the value of the decision?
Alternative Demand Minum of each row

(.5 (.20)
0)
4 Rooms 15 20 25 15
8 Rooms 10 35 50 10
12 Rooms 5 50 75 5
The Maximin is to choose 15 which is 4 rooms

Alternative Demand Opportunity Loss

(.5 (.20)
0)
4 Rooms 0 30 50 50
8 Rooms 5 15 25 25
12 Rooms 10 0 0 10
Smallest maximum loss is to choose 12 rooms the value of the decision is 10
3. Using the information in Table 2, what decision would be made if the equal likelihood criterion is used?
What is the value of the decision?
Alternative Demand Average of the row Expected Value

Equally Likely
(.5 (.20)
0)
4 Rooms 15 20 25 20 19.5
8 Rooms 10 35 50 31.3 30.5
12 Rooms 5 50 75 43.3 41.5
1. Select the decision with the highest weighted value 12 rooms the value of the decision = 43.3
2. Using the information in Table 2, what is the expected value of each alternative? What is the best
decision?
EV for 4 rooms = 15*0.30 + 20 * 0.50 + 25 * 0.20 = 4.5+10+5

EV= 19.5
EV for 8 rooms = 10 * 0.30 + 35 * 0.50 + 50 * 0.20 = 3+17.5+10

EV= 30.5
EV for 12 rooms= 5 * 0.30 + 50 * 0.50 + 75 * 0.20 = 1.5+25+15

EV= 41.5
3. The best decision to choose 12 rooms the value of the decision = 41.5

4. Using the information in Table 2, draw a decision tree for the problem. Be sure to carefully label the
branches of the tree and provide the value at each node.

Problem 4:
0.3
Low
15000
15,000 15000
0.5
4 Rooms Mod.
20000
0 19500 20,000 20000
0.2
Heavy
25000
25,000 25000
0.3
Low
10000
10,000 10000
0.5
8 Rooms Mod.
3 35000
41500 0 30500 35,000 35000
0.2
Heavy
50000
50,000 50000
0.3
Low
5000
5,000 5000
0.5
12 Rooms Mod.
50000
0 41500 50,000 50000

5. A company is introducing a new product and must decide how much capacity will be needed to
manufacture it. They developed Table 3 showing expected costs for the first year (€ 000’s).
Table 3
Costs (€ millions)
Alternative Failure Moderate Great success
(0.30) success (0.20)
(0.50)
Develop new process 40 50 55
Use present process 20 75 100
Subcontract 100 80 75
1. Using the information in Table 3, what alternative would be chosen if the maximax criterion is used?
Costs (€ millions) Maximum of

Alternative each
row
Failure Moderate success Great success (0.20)
(0.30) (0.50)
Develop new 40 50 55 55
process
Use present 20 75 100 100
process
Subcontract 100 80 75 100
The maximax criterion will be use present process or subcontract the vale is = 100
2. Using the information in Table 3, what decision would be made if the maximin criterion is used? What is
the value of the decision?
Costs (€ millions) Minim of each

Alternative row
Failure Moderate success Great success (0.20)
(0.30) (0.50)
Develop new process 40 50 55 40
Use present process 20 75 100 20
The maximin criterion will be subcontract and the value is 75

3. Using the information in Table 3, what decision would be chosen if the minimax regret criterion is used?
Costs (€ millions) Maximum of

Alternative each
row
Failure Moderate Great success (0.20)
(0.30) success
(0.50)
Develop new 40 50 55 55
process
Use present 20 75 100 100
process
The minimax criterion to be develop new process and the value is 55
4. Using the information in Table 3, what decision would be chosen if the equal likelihood criterion is
used? What is the value of the decision?
Costs (€ millions) Average of each

Alternative row
Failure Moderate success Great success (0.20) Weighted
(0.30) (0.50) Value
Develop new process 40 50 55 45
Use present process 20 75 100 65
1. Select the decision with the highest weighted value which is subcontract and the value is 85
2. Using the information in Table 3, what is the expected value of the best decision? What is the value of
the decision?
Develop new process EV = 40 * 0.30 + 50 * 0.50 + 55 * 0.20 = 12+25+11=48
Use present process EV= 20 * 0.30 + 75 * 0.50 + 100 * 0.20 = 6+37.5+20=63.5
Subcontract EV= 100 * 0.30 + 80 * 0.50 + 75 * 0.20 = 30+40+15=85
The best decision is Subcontract

The value of the best decision is 85

3. Using the information in Table 3, draw a decision tree for the problem. Be sure to carefully label the
branches of the tree and provide a value at each node.

Problem 3:
0.3
Failure
40
40 40
0.5
Develop New Process Moderate Success
50
0 48 50 50
0.2
Great Success
55
55 55
0.3
Failure
20
20 20
0.5
Use Present Process Moderate Success
3 75
85 0 63.5 75 75
0.2
Great Success
100
100 100
0.3
Failure
100
100 100
0.5
Subcontract Moderate Success
80
0 85 80 80

4. The profit level for a furniture manufacturer using three different plants 1, 2, and 3 and the demand level
A, B, and C, is given by the following table (0,000 of dollars).
Plant Demand
A B C
1 200 350 600
2 250 350 540
3 300 375 490
Using the previous information, what decision would be made using the:
1. The maximax criterion?
Plant Demand Maximum of each row

A B C
1 200 350 600 600
2 250 350 540 540
3 300 375 490 490
The maximax criterion is Plant 1 the value is 600
2. The maximin criterion?
Plant Demand Minimum of each row

A B C
1 200 350 600 200
2 250 350 540 250
3 300 375 490 300
The maximin criterion is Plant 3 the value is 300
3. The minimum regret criterion?
Plant Demand Opportunity Loss

A B C
1 100 125 0 125
2 50 25 60 60
3 0 0 110 110
Smallest maximum loss is to choose Plant 2 the value is 60

4. The material manager of a company is trying to determine if his company should purchase a certain part
or produce it in-house. If purchased, it will cost $8 per unit. The company can make it for $5 per unit
with a fixed cost of $7,500 on a high-speed machine. Or it can make it using limited automation at a
variable cost of $6 per unit with a fixed cost of $4,000. Which alternative should the manager select?
Units Demanded Probability

7000 0.15
8000 0.45
9000 0.40


5. Driveway Trucking is planning to increase capacity by purchasing new buses for its over-the-road fleet.
Driveway's management does not know how many buses to add. Each additional bus can make three
trips per week on the average. Each trip generates $ 1500 in revenue and incurs a variable cost of about
$700. The annual cost to operate one bus including depreciation is $80,000. Following is the distribution
of demand that cannot be satisfied with the existing fleet. How many buses can Driveway profitably add
to the fleet based on 50 weeks per year calculations?
Unsatisfied Demand 9 15 21 24
Probability 20% 20% 30% 30%

Problem 5:
1
Buy 3 Buses 9 Trips
120000
-240000 120000 360000 120000
1
Buy 4 Buses 9 Trips
40000
-320000 40000 360000 40000
0.2
9 Trips
-40000
Buy 5 Buses 360000 -40000
-400000 152000 0.8

15 Trips
200000
600000 200000
3
152000 0.2
9 Trips
-120000
Buy 6 Buses 360000 -120000
-480000 72000 0.8

15 Trips
120000
600000 120000
0.2
9 Trips
-200000
360000 -200000
0.2
Buy 7 Buses 15 Trips
40000
-560000 136000 600000 40000
0.6
21 Trips
280000
840000 280000
0.2
9 Trips
-280000
360000 -280000
0.2

6. A supermarket is expanding its operations. Its first step is to build a warehouse to satisfy demand in the
eastern part. The supermarket has an option to build either a large or small warehouse. The expected
demand per year for the supermarket’s products is shown below:
Annual demand (units/yr) Probability

450,000 0.2
300,000 0.5
200,000 0.3
The company is evaluating the decision on a four-year time horizon. Demand in the first year is
expected to hold for the other three years. Revenue per unit is L.E.8. The small facility has a variable
cost of L.E. 2.9 per unit, a 350,000 fixed cost per year, and a L.E.2, 500,000 construction cost. The large
facility has a variable cost of L.E. 1.8 per unit, a 500,000 fixed cost per year, and a L.E.4, 750,000
construction cost. The other proposal is suggest doing nothing and staying as a present situation with
expected lost seals of L.E. 1,250,000 per year. What should the company do?

Problem 6:
0.2
450,000
4410000
11160000 4410000
0.5
Build Large Facility 300,000
690000
-6750000 690000 7440000 690000
0.3
200,000
-1790000
4960000 -1790000
0.2
450,000
5280000
9180000 5280000
0.5
Build Small Facility 300,000
3 2220000
4,600,000 -3900000 2220000 6120000 2220000
0.3
200,000
180000
4080000 180000
0.2
450,000
9400000
14400000 9400000
0.5
Do Nothing 300,000
4600000
-5000000 4600000 9600000 4600000
0.3
200,000
1400000
6400000 1400000

7. Given the following sequential decision tree, the revenue value of each possibility is shown in the
decision tree. Determine which is the optimal investment, A or B.?


8. Computrade Computer Repair Company is faced with greater demand than its present work force can
handle. It is considering how to expand service. One proposal would add four new repair persons. This
would increase annual fixed operating costs by $ 100,000 for personnel and other related costs such as
equipment. Three new service persons would require an additional $ 80,000 in annual fixed costs, and
two would add $ 60,000.
The variable operating cost per trip would average $ 4.50, and the average revenue per trip is $ 45.00
regardless of adding four, three, or two people. On the average, each worker can make 3.5 trips per day.
Base the calculations on 250 working days per year. Following is the distribution of trips per day that
cannot be satisfied with the present work forces:
Trips per day Probability

5 0.02
6 0.08
7 0.10
8 0.12
9 0.20
10 0.20
11 0.16
12 0.10
13 0.02

9. Moon Micro is a small manufacturer of servers that currently builds all of its product in Santa Clara,
California. As the market for servers has grown dramatically, the Santa Clara plant has reached capacity
of 10,000 servers per year. Moon is considering two options to increase its capacity. The first option is to
add 10,000 units of capacity to the Santa Clara plant at an annualized fixed cost of $10,000,000 plus $500
labor per server. The second option is to have Molectron, an independent assembler, manufacture
servers for Moon at a cost of $2,000 for each server (excluding raw materials cost). Raw materials cost
$8,000 per server, and Moon sells each server for $15,000.
Moon must make this decision for a two-year time horizon. During each year, demand for Moon servers
has an 80 percent chance of increasing 50 percent from the year before and a 20 percent chance of
remaining the same as the year before. Molectron’s pieces may change as well. They are fixed for the
first year but have a 50 percent chance of increasing 20 percent in the second year and a 50 percent
chance of remaining where they are.
Use decision tree to determine whether Moon should add capacity to its Santa Clara plant or if it should
outsource to Molectron. What are some other factors that would affect this decision that we have not
discussed?

Problem 9:
First Year Second Year
0.8
Demand
increases by
50%
0.8
Demand
increases by
50% 225000000
225000000 415000000 0.2

Demand
remains at
same level
Add 10,000
units of
capacity 150000000
-20000000 400000000 0.8

Demand
increases by
50%
0.2
Demand
remains at
same level 225000000
150000000 340000000 0.2

1 Demand
remains at
same level
400000000

10. Jerry Bauman’s company is considering expansion of its current facility to meet increasing demand. If
demand is high in the future, a major expansion would result in an additional profit of $800,000, but if
demand is low there would be a loss of $500,000. If the demand is high a minor expansion would result
in an increase in profits of $200,000, but if demand is low, there is a loss of $100,000. The company has
the option of not expanding. If there is a 50% chance demand will be high, what should the company do
to maximize long-run average profit?

Problem 10:
0.5
High Demand
800000
Major Expansion 800,000 800000
0 150000 0.5
Low Demand
-500000
-500,000 -500000
0.5
High Demand
200000
1 Minor Expansion 200,000 200000
150000
0 50000 0.5
Low Demand
-100000
-100,000 -100000
No Expansion
0
0 0

11. The ABC Oil Company is considering making a bid for a shale oil development contract to be awarded
by the federal government. The company has decided to bid $110 million. The company estimates that it
has a 60% chance of winning the contract with this bid. If the firm wins the contract, it can choose one
of three methods of oil extraction. The methods with their probability are give as follows:
Develop New Process

Outcomes Probability Profit(millions)
Great success 0.30 600
Moderate success 0.60 300
Failure 0.10 -100
Use Present Process
Great success 0.50 300
Failure 0.20 -40
Subcontract
The cost of preparing the contract proposal is $2,000,000. If the company does not make the bid, it will
invest in an alternative venture with a guaranteed profit of $30 million. Construct a sequential decision
tree, and determine whether the company should make the bid.

Problem 11:
0.3
Great Success
600000000
0.33333333 0.6
Develop New Process Moderate Success
0 348000000 300000000
0.1
Failure
-100000000
0.5
Great Success
Make the
bid 300000000
-2000000 265333333.3 0.33333333 0.3

Use Present Process Moderate Success
0 200000000 200000000
0.2
Failure
1 -40000000
265333333.3
0.33333333 1
Subcontract Moderate Success
0 248000000 250000000
1
Do not
make the
bid Alternative Venture

12. The management of State Union Bank was concerned about the potential loss that might occur in the
event of a physical catastrophe such as a power failure or fire. The bank estimated that the loss from one
of these incidents could be as much as $100 million, including losses due to interrupted service and
customer relations. One project the bank is considering is the installation of an emergency power
generator at its operations headquarters. The cost of the emergency generator is $900,000, and if it’s
installed no losses from this type of incident will be incurred. However, if the generator is not installed,
there is a 10% chance that a power outage will occur during the next year. If there is an outage, there is a
0.04 probability that the resulting losses will be very large, or approximately $90 million in lost earnings.
Alternatively, it’s estimated that there is a 0.96 probability of only slight losses of around $2 million.
Using decision tree analysis, determine whether the bank should install the new power generator.

Problem 12:
Installing
New
Power
Generator
-900,000 -900,000
0.04
Large losses
2 0.1
-552,000 Power Outtage -90,000,000 -90000000
0 -5520000 0.96
Slight Losses
Not installing
-2,000,000 -2000000
0 -552000
0.9
Nothing
0 0

13. Volks Wagen is expanding its operations. Its first step is to build a manufacturing facility near Leipzig to
satisfy the demand on in the eastern part. Volks Wagen has the option to build either a large facility that
has an output of 500,000 units per year or a small facility with an output of 300,000 units per year. The
Expected demand for the company’s products is shown below:
Annual Demand Probability

(units/year)
450,000 0.15
300,000 0.50
200,000 0.35
The company is evaluating the decision on a four-year time horizon. Demand in the first year is
expected to hold for the other three years. Revenue per unit is $8.00. The small facility has a variable
cost of $2.9/unit and a fixed cost of $350,000. The large facility has a variable cost of $1.8/unit and a
fixed cost of $500,000.
1. What decision should be made, using the decision tree analysis?

2. Suppose Volks Wagen has a potential competitor. There is a probability of 0.7 that that the competitor
will enter the market if demand is high, and if Volks Wagen builds only a small facility initially, it may
consider building another small facility. The competitor and Volks Wagen wouldn’t finish construction
of the new facilities until the end of the second year. If the competitor builds a new facility, its share of
the demand in the third year will be 25%, and in the fourth year, it’ll be 40%. What should Volks do?

Problem 13:
0.15
High Demand
-950,000
450,000 -950,000
0.5
Large Facility Moderate Demand
-1,100,000
-1,400,000 -1112500 300,000 -1,100,000
0.35
Low Demand
-1,200,000
200,000 -1,200,000
2
-932500 0.15
High Demand
-770,000
450,000 -770,000
0.5
Small Facility Moderate Demand
-920,000
-1,220,000 -932500 300,000 -920,000
0.35
Low Demand
-1,020,000
200,000 -1,020,000

Decison Making and Trees Problems Solutions-Final

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Decison Making and Trees Problems Solutions-Final

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Decision Making and Trees Problems Solution

Decision making and trees

Prof. M Hamdy Elwany

Hesham Baraka – [DBA intake 4] Page 1

Exercise Decision Tree

Using the previous information:

Hesham Baraka – [DBA intake 4] Page 2

$58,500 .20 High 50

Hesham Baraka – [DBA intake 4] Page 3

Units Demanded Probability of Demand

Hesham Baraka – [DBA intake 4] Page 4

Hesham Baraka – [DBA intake 4] Page 5

Trips per day Probability

MP = $45 - $4.5 = $40.5

Hesham Baraka – [DBA intake 4] Page 6

2) Construct a probability table

Trips per day Probability P*(the probability of sales

Hesham Baraka – [DBA intake 4] Page 7

Investment Profit in $1,000’s Maximu

Hesham Baraka – [DBA intake 4] Page 8

2. Greatest maximum is to choose large plant

Investment Profit in Mini

Large plant 10 60 100 10

Hesham Baraka – [DBA intake 4] Page 9

2. Greatest Minimum is to choose Small plant

Investment choice Profits in $1,000’

Opportunity Loss Table

Hesham Baraka – [DBA intake 4] Page 10

Minimax Regret Solution

1. Maximum Op. Loss

2. Smallest maximum loss is to choose medium plant

Hesham Baraka – [DBA intake 4] Page 11

1. Calculate the average payoff for each alternative

To calculate raw averages:

2. Select the decision with the highest weighted value

Expected Value Solution

Large plant 10 60 100 53

EV (Small Plant) = 40 (0.3) + 50 (0.5) + 55 (0.2) = 48

2. Maximize expected value by choosing large plant

Hesham Baraka – [DBA intake 4] Page 12

1. Telecomp is a manufacture of cellular telephones. It is planning to build a new manufacturing and

A) The minimin is 12.5 in Oman

B) The Mini max is 19.0 in Syria

Hesham Baraka – [DBA intake 4] Page 13

C) The equal likelihood

Select the decision with the highest weighted value

0.30 0.40 0.30 EV

Egypt EV = 21.7 * 0.30 + 19.1 * 0.40 + 15.2 * 0.30 =

= 6.51 + 7.64 + 4.56 = 18.71

Syria EV = 19.0 * 0.30 + 18.5 * 0.40 + 17.6 * 0.30 =

= 5.7 + 7.4 + 5.28 = 18.38

UAE EV = 19.2 * 0.30 + 17.1 * 0.40 + 14.9 * 0.30 =

= 5.67 + 6.84 + 4.47 = 16.98

Kuwait EV = 22.5 * 0.30 + 16.8 * 0.40 + 13.8 * 0.30=

= 6.75 + 6.72 + 4.14 = 17.61

Oman EV = 25 * 0.30 + 21.2 * 0.40 + 12.5 * 0.30 =

= 7.5 + 8.48 + 3.75 = 19.73

Maximize expected value by choosing large plant

Hesham Baraka – [DBA intake 4] Page 14

1. What decision would be made using the maximax criterion?

1. What decision would be made using the maximax criterion?

Decision a b c Maximum of each

A1 decision value = 250

EV for 4 rooms = 150.30 + 20 0.50 + 25 * 0.20 = 4.5+10+5