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Notes from a management class discussing decision making in a custom clothing store. The store is considering building a new facility in another town and must decide between three alternatives: a 2000 sq. Ft., a 10,000 sq. Ft., or a 20,000 sq. Ft. Facility. The notes include information on decision theory, expected monetary value, and decision trees to help determine the best alternative based on various demand scenarios and probabilities.
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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.
n j EVi PjV ij 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?
b. Decision Trees are a graphical representation of the decision process. Trees have three elements, chance nodes, decision nodes and branches. Branches that come out of chance nodes are possible outcomes, branches that come out of decision nodes are alternatives. Trees are drawn from left to right and analysis is made from right to left. Let’s make a tree for our example. (see board). Calculations are similar to expected value. Trees may have many levels (an advantage over the table), but we’ll stop at three levels. c. Expected Value of Perfect Information (EVPI). How much would you pay if you knew what was going to happen in the future? Need to calculate EVcertainty and EVrisk, where: EVPI = EVcertainty - EVrisk We have already calculated EVrisk (in step b above), how do we calculate EVcertainty? We determine the best payoff for each state of nature (column) and multiply this best payoff by the probability of that state of nature occurring then sum these values across state of natures.
n j EVcertaint y PjV j 1
(where V^ * j is the best value for a state of nature j ) Quality Video…