MGMT250 Notes September 9, 2004
1. Initial Stuff
A. Schedule
1. Return Homeworks (type it up if text, etc.)
2. We have a Tour….Polar Beverages, Tuesday, Nov. 9, 8:00 am.
3. We will try to finish up Decision Theory today.
4. Case Analysis due next Thursday.
5. Problems for Chapter 5S due next class.
6. For next week read quality assignments. Will try to start Quality today by looking at an overview video, if
time allows.
2. Decision Theory
Questions to begin:
1. What are different decision environments and their characteristics?
2. What are the major elements of the decision analysis for setting up a problem?
3. What were the major methods/criteria used for uncertain environment?
4. What was solution to the problem last time? Which alternative to select?
5. How do we set up/ read the payoff table?
To further complete the payoff table…
4. Determine likelihood of states of nature
5. Evaluate alternatives based on some “criteria”, (e.g. maximize profit) and make selection.
Let us assume that we have a company a custom clothing store, is looking to its future. Business for
this company has been good and it’s looking to build another store in another town. There are a
number of alternatives available to them, they could build a facility with 2000 sq. ft, a facility with
10,000 sq. ft. or a 20,000 sq. ft. facility. They decided to have some estimation done and came up
with the following preliminary numbers. If they built the 2000 sq. ft. facility and demand was low (100
suits a day), then they could expect a net present value on the facility (over the life of the facility) of
$5 million. Actually, this is true if demand is at 400 or 1000 suits per day (the other demand
estimates). If they built the 10,000 sq. ft. facility they would make $3 million with the 100 suit/day
demand, $10 million with the 400 suit/day demand and $12 million, for the 1000 suit/day demand.
Yet, if they built the 20,000 sq. ft. facility, they could expect to lose $4 million over the life of the store
if demand was 100 suit/day. If demand were 400 or 1000 suits/day his returns would be $2 million and
$16 million respectively.
B. Decision Making Under Risk
Sometimes information may be given to you, but only as possible occurrences, e.g. stochastic
environment.
i. you can use expected monetary value (EMV) or expected value as criterion in this case. The
environment here assumes that each state of nature has some probability that it will occur.
The summation of the probabilities is 1 with each state of nature falling between 0 and 1.
Let’s go back to clothing store. Assume the manager hired a marketing consultant to do some initial
research, this consultant found that the probability for demand being 100 suit/day is 0.3 (30%), while
the 400 or 1000 suit/day demand had 20% and 50% chance of occurring, respectively.
Equation to determine this is:
n
j
ijji
VPEV
1
Where EVi is the total expected monetary value for alternative i, Pj is the probability of outcome (state
of nature) j occurring and Vij is the payoff associated with alternative i under outcome j. n is the
number of outcomes.
What are the expected payoffs for each of the three alternatives? Which one would you select?
