HOMEWORK ASSIGNMENT 1 DECISION ANALYSIS AND
SIMULATION- 2015
Question1. Colaco currently has assets of $150000 and wants to decide whether to market a
new chocolate-flavoured soda, Chocola. Colaco has three alternatives:
Alt 1. Test market Chocola locally, then utilize the results of the market study to determine
whether or not to market Chocola nationally.
Alt 2. Immediately (without test marketing) market Chocola nationally.
Alt 3. Immediately (without test marketing) decide not to market Chocola nationally.
In the absence of the market study, Colaco believes that Chocola has a 55% chance of being a
national success and a 45% chance of being a national failure. If Chocola is a national
success, Colacos asset position will increase by $300,000 and if Chocola is a national failure,
Colacos asset position will decrease by $100,000.
If Colaco performs a market study (at a cost of $30,000), there is a 60% chance that the study
will yield favourable results and a 40% chance that the study will yield unfavourable results.
If a local success is observed, there is an 85% chance that Chocola will be a national success.
If Colaco is risk-neutral, what strategy should the company follow? Draw a decision tree that
represents Colacos problem.
Question 2. ABC air express has decided to offer direct service from Cleveland to Myrtle
Beach. Management must decide between a full-price service using the companys new fleet
of jet air craft and a discount service using smaller capacity commuter planes. It is clear that
the best choice depends on the market reaction to the service ABC offers. Management
developed estimates of the contribution to profit for each type of service based upon two
possible levels of demand for service to Myrtle Beach: strong and weak. The following table
shows the estimated quarterly profits in thousands of dollar.
Service
Full price
Disocunt
i.
Demand for service
Strong
Weak
$960
-$490
$670
$320
What is the decision to be made? What is the chance event? How many decision alternatives
are there? How many outcomes are there for the chance event?
ii. If nothing is known about the probabilities of the chance outcomes, what is the recommended
decision using optimistic, conservative and minimax regret approaches?
iii. Suppose the management of ABC air express believes that the probability of strong demand
is 0.7 and probability of weak demand is 0.3. Use the expected value approach to
determine an optimal decision. Also calculate the EVPI under this condition.
iv. Suppose that the probability of strong demand is 0.8 and probability of weak demand is 0.2,
what is the optimal decision using the expected value approach? Also calculate the EVPI
under this condition.
Question 3. Netra is in the process of buying a car and has narrowed the choices to three
models: M1, M2, and M3. The deciding factors include purchase price (PP), maintenance
cost (MC), cost of city driving (CD), and cost of rural driving (RD). The following table
provides the payoff matrix for 3 years of operation:
Car model
PP ($)
MC($)
CD ($)
RD ($)
M1
6000
1800
4500
1500
M2
8000
1200
2250
750
M3
10,000
600
1125
600
For each of the following decision criteria, determine the optimal decision:
a. Netra has always been a very optimistic decision maker. Which alternative is best
from Netras point of view?
b. Suppose Netra attributes her buying decision to her pessimistic attitude. Which
alternative is best from Netras point of view?
c. Which option should Netra choose if she is a neutral person?
d. The probabilities for the 4 alternatives PP, MC,CD, and RD for the decision to buy
car with M1, M2 and M3 are given as 0.3, 0.4, 0.2 and 0.1 respectively. If Netra uses
these probabilities in determining the best decision, which decision is the best?
e. Which option should Netra choose if she uses the regret criterion?
f. Compute Netras EVPI.
Question 4. Pierres bakery bakes and sells French bread. Each morning, the bakery satisfies the
demand for the day using freshly baked bread. Pierres can bake the bread only in batches of a
dozen loaves each. Each loaf costs 25 cents to make. For simplicity, we assume that the total
daily demand for bread also occurs in multiples of 12. Past data have shown that this demand
ranges from 36 to 96 loaves per day. A loaf sells for 40 cents, and any bread left over at the end
of the day is sold to a charitable kitchen for a salvage price of 10 cents per loaf. If demand
exceeds supply, we assume that there is a lost-profit cost of 15 cents per loaf (because of loss of
goodwill, loss of customers to competitors, and so on). The bakery record show that the daily
demand can be categorized into three types: high, average and low. These demands occur with
probabilities of .30, .45 and .25, respectively. The distribution of the demand by categories is
given below:
Table: Demand distribution by Demand Categories
Demand probability distribution
Demand
High
Average
36
.05
.10
48
.10
.20
60
.25
.30
72
.30
.25
84
.20
.10
96
.10
.05
Pierres would like to determine the optimal number of loaves to bake
profit (revenue + salvage revenue cost of bread cost of lost profits).
Low
.15
.25
.35
.15
.05
.05
each day to maximize
