Scribd
Upload
16 views3 pages

Decision Analysis Notes - Lecture 2

The document discusses decision analysis in operations research, focusing on probabilistic decision criteria such as Expected Value (EV) and Expected Opportunity Loss (EOL). It provides calculations for different investment choices (Large, Medium, and Small Factory) under various economic conditions, concluding that the Medium Factory maximizes EV and minimizes EOL. Additionally, it explains the Cost of Uncertainty, or Expected Value of Perfect Information (EVPI), which is calculated to be TZS 43,000,000.

Uploaded by

eliamugini444
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
16 views3 pages

Decision Analysis Notes - Lecture 2

The document discusses decision analysis in operations research, focusing on probabilistic decision criteria such as Expected Value (EV) and Expected Opportunity Loss (EOL). It provides calculations for different investment choices (Large, Medium, and Small Factory) under various economic conditions, concluding that the Medium Factory maximizes EV and minimizes EOL. Additionally, it explains the Cost of Uncertainty, or Expected Value of Perfect Information (EVPI), which is calculated to be TZS 43,000,000.

Uploaded by

eliamugini444
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

INSTITUTE OF ACCOUNTANCY ARUSHA

MODULE: OPERATIONS RESEARCH - AFU07437 / BMU07424 / SSU07404

TOPIC: DECISION ANALYSIS

Lecture 2

Probabilistic Decision Criteria:

Expected Value Solution:

The expected value is the weighted average payoff, given specified probabilities for
each state of nature.

Investment Choice Profit in TZS 1,000,000’s


(Alternatives) (States of Nature)
Strong Economy Stable Economy Weak Economy
0.3 0.5 0.2
Large Factory 200 50 -120
Medium Factory 90 120 -30
Small Factory 40 30 20

Suppose these probabilities


have been assessed for these
states of nature

Compute the Expected Value (EV) for each alternative.

Example: EV (Medium Factory) = 90(0.3) + 120(0.5) + (-30)(0.2) = 81

Investment Choice Profit in TZS 1,000,000’s


(Alternatives) (States of Nature)
Strong Economy Stable Economy Weak Economy
0.3 0.5 0.2 Expected
Values
Large Factory 200 50 -120
61
Medium Factory 90 120 -30
81
Small Factory 40 30 20 31

The maximum EV is TZS 81,000,000.


Therefore maximize the Expected Value by choosing Medium Factory.

Expected Opportunity Loss Solution:

1
Compute the Expected Opportunity Loss (EOL) for each alternative.

Example: EOL (Large Factory) = 0(0.3) + 70(0.5) + (140)(0.2) = 63

Investment Choice Opportunity Loss in TZS 1,000,000’s


(Alternatives) (States of Nature)
Expected
Strong Economy Stable Economy Weak Economy
Opportunity
0.3 0.5 0.2
Loss (EOL)
Large Factory 0 70 140 63
Medium Factory 110 0 50 43
Small Factory 160 90 0 93

The minimum EOL is TZS 43,000,000.


Therefore minimize the Expected Opportunity Loss by choosing Medium Factory.

Cost of Uncertainty:
Cost of Uncertainty is also referred to as Expected Value of Perfect Information, or
EVPI.

Expected Value of Perfect Information, or EVPI= Expected Value with Perfect


Information (EV with PI) – Expected Value without information (EV)

So, EVPI = EV with PI – EV

Investment Choice Profit in TZS 1,000,000’s


(Alternatives) (States of Nature)
Strong Economy Stable Economy Weak Economy
0.3 0.5 0.2
Large Factory 200 50 -120
Medium Factory 90 120 -30
Small Factory 40 30 20

200 120 20

Example: Best decision


given “Strong Economy”
is “Large Factory”
Now weight these outcomes with their probabilities to find EV with PI:

EV with PI = expected value of the best decision, given perfect information.


= 200(0.3)+120(0.5)+20(0.2) = 124

Therefore the expected value of perfect information is TZS 124,000,000.

Cost of Uncertainty Solution:


2
Cost of Uncertainty (EVPI) = Expected Value with Perfect Information (EV with PI)–
Expected Value without information (EV)

Recall: EV with PI = TZS 124,000,000


EV is maximized by choosing “Medium Factory”,where EV = TZS 81,000,000.

So: EVPI = EV with PI – EV


= 124,000,000 – 81,000,000
= TZS 43,000,000

You might also like