A nuclear power company is deciding whether or not tobuild a nuclear power plant at Diablo Canyon or at RoyRogers City. The cost of building the power plant is $10million at Diablo and $20 million at Roy Rogers City. If thecompany builds at Diablo, however, and an earthquakeoccurs at Diablo during the next five years, constructionwill be terminated and the company will lose $10 million(and will still have to build a power plant at Roy RogersCity). A priori, the company believes there is a 20% chancethat an earthquake will occur at Diablo during the next fiveyears. For $1 million, a geologist can be hired to analyze thefault structure at Diablo Canyon. He will either predict thatan earthquake will occur or that an earthquake will notoccur. The geologist’s past record indicates that he willpredict an earthquake on 95% of the occasions for which anearthquake will occur and no earthquake on 90% of theoccasions for which an earthquake will not occur. Shouldthe power company hire the geologist? Also find EVSI andEVPI.

A nuclear power company is deciding whether or not tobuild a nuclear power plant at Diablo Canyon or at RoyRogers City. The cost of building the power plant is $10million at Diablo and $20 million at Roy Rogers City. If thecompany builds at Diablo, however, and an earthquakeoccurs at Diablo during the next five years, constructionwill be terminated and the company will lose $10 million(and will still have to build a power plant at Roy RogersCity). A priori, the company believes there is a 20% chancethat an earthquake will occur at Diablo during the next fiveyears. For $1 million, a geologist can be hired to analyze thefault structure at Diablo Canyon. He will either predict thatan earthquake will occur or that an earthquake will notoccur. The geologist’s past record indicates that he willpredict an earthquake on 95% of the occasions for which anearthquake will occur and no earthquake on 90% of theoccasions for which an earthquake will not occur. Shouldthe power company hire the geologist? Also find EVSI andEVPI.

Practical Management Science

6th Edition

ISBN:9781337406659

Author:WINSTON, Wayne L.

Publisher:WINSTON, Wayne L.

Chapter9: Decision Making Under Uncertainty

Section: Chapter Questions

Problem 36P

See similar textbooks

Similar questions

You now have 10,000, all of which is invested in a sports team. Each year there is a 60% chance that the value of the team will increase by 60% and a 40% chance that the value of the team will decrease by 60%. Estimate the mean and median value of your investment after 50 years. Explain the large difference between the estimated mean and median.
A firm that plans to expand its product line must decide whether to build a small or a large facilityto produce the new products. If it builds a small facility and demand is low, the net present valueafter deducting for building costs will be $400,000. If demand is high, the firm can either maintainthe small facility or expand it. Expansion would have a net present value of $450,000, and maintaining the small facility would have a net present value of $50,000.If a large facility is built and demand is high, the estimated net present value is $800,000. If demandturns out to be low, the net present value will be – $10,000.The probability that demand will be high is estimated to be .60, and the probability of low demandis estimated to be .40.a. Analyze using a tree diagram.
A firm that plans to expand its product line must decide whether to build a small or a large facilityto produce the new products. If it builds a small facility and demand is low, the net present valueafter deducting for building costs will be $400,000. If demand is high, the firm can either maintainthe small facility or expand it. Expansion would have a net present value of $450,000, and maintaining the small facility would have a net present value of $50,000.If a large facility is built and demand is high, the estimated net present value is $800,000. If demandturns out to be low, the net present value will be – $10,000.The probability that demand will be high is estimated to be .60, and the probability of low demandis estimated to be .40. 1- Compute the EVPI 2- Determine the range over which each alternative would be best in terms of the value of P ( low demand )
A store owner must decide whether to build a small or a large facility at a new location. Demand at a location can be either small or large, which probabilities estimated to be 0.4 and 0.6, respectively. If small facility is built and demand proves to be high, the manager may choose not to expand (payoff=P235,000) or to expand (payoff=P275,000). If a small facility is built and demand is low, there is no reason to expand and the payoff is P220,000. If a large facility is built and demand proves to be low, the choice is to do nothing (P60,000) or to stimulate demand through local advertising. The response to advertising may be either modest or sizable, with their probabilities estimated to be 0.3 and 0.7, respectively. If it is modest, the payoff grows to P230,000 if the response is sizable. Finally, if a large facility is built and demand turns out to be high, the payoff is P900,000.a.) Draw a decision tree.b.) Determine the expected payoff for each decision and event node.c.)…
A small strip-mining coal company is trying to decide whether it should purchase or lease a new clamshell. If purchased, the “shell” will cost $152,500 and is expected to have a $50,000 salvage value after 6 years. Alternatively, the company can lease a clamshell for only $16,000 per year, but the lease payment will have to be made at the beginning of each year. If the clamshell is purchased, it will be leased to other strip-mining companies whenever possible, an activity that is expected to yield revenues of $9,000 per year. If the company’s MARR is 13% per year, should the clamshell be purchased or leased on the basis of a future worth analysis? Assume the annual M&O cost is the same for both options. The future worth when purchased is $ The future worth when leased is $
Eunice, in The scenario, wants to determine how each of the 3 companies will decide onpossible new investments. He was able to determine the new investment pay off for eachof the three choices as well as the probability of the two types of market. If a company willlaunch product 1, it will gain 125,000 if the market is successful and lose 125,000 if themarket is a failure. If a company will launch product 2, it will gain 75,000 if the market issuccessful and lose 75,000 if the market will fail. If a company decides not to launch anyof the product, it will not be affected whether the market will succeed or fail. There is a53% probability that the market will succeed and 47% probability that the market will fail.What will be the companies decision based on EMV? What is the decision of eachcompany based on expected utility value?
A retailer must decide whether to build a small or a large facility at a new location. Demand at the location can be either low or high, with probabilities estimated to be 0.4 and 0.6, respectively. If a small facility is built and demand proves to be high, the manager may choose not to expand (payoff = $223,000) or to expand (payoff = $270,000). If a small facility is built and demand is low, there is no reason to expand and the payoff is $200,000. If a large facility is built and demand proves to be low, the choice is to do nothing ($40,000) or to stimulate demand through local advertising. The response to advertising may be either modest or sizable, with their probabilities estimated to be 0.3 and 0.7, respectively. If it is modest, the payoff is estimated to be only $20,000; the payoff grows to $220,000 if the response is sizable. Finally, if a large facility is built and demand turns out to be high, the payoff is $800,000.Draw a decision tree. Then analyze it to determine the…
A manager wants to expand summer resort facilities now or wait at least another year. If he expands now and the upcoming summer season is good, the profit will be K246 000; and if not good, the loss will be K60 000. If he delays the expansion for at least a year and the upcoming summer season is good, the profit will be K120 000; if the season is poor, the profit will be K12 000. Required: Assuming the probability of a good summer in both cases is 1/3, use Bayesian analysis to aid the manager.
Which investment should Warren make under each of the following criteria? a. Maximax criterion. b. Maximin criterion. c. Maximum likelihood criterion. d. Bayes’ decision rule. e. The investor decides that Bayes’ decision rule is his most reliable decision criterion. He believes that 0.1 is just about right as the prior probability of an improving economy, but is quite uncertain about how to split the remaining probabilities between a stable economy and a worsening economy. Therefore, he now wishes to do some sort of sensitivity analysis with respect to these latter two prior probabilities. If he still wants to choose the alternative from the Bayes’ decision rule (part d): e1. How much would be the maximum amount of the prior probability of a stable economy? e2. How much would be the minimum amount of the prior probability of a worsening economy?
Many decision problems have the following simplestructure. A decision maker has two possible decisions,1 and 2. If decision 1 is made, a sure cost of c isincurred. If decision 2 is made, there are two possibleoutcomes, with costs c1 and c2 and probabilities p and1 2 p. We assume that c1 , c , c2. The idea is thatdecision 1, the riskless decision, has a moderate cost,whereas decision 2, the risky decision, has a low costc1 or a high cost c2.a. Calculate the expected cost from the riskydecision.b. List as many scenarios as you can think of thathave this structure. (Here’s an example to get youstarted. Think of insurance, where you pay a surepremium to avoid a large possible loss.) For eachof these scenarios, indicate whether you wouldbase your decision on EMV or on expected utility.
Mr. Albert Richardson, a financial advisor at NNW Investments identified two companies that are likely candidates for a takeover in the near future. East End Cable is a leading manufacturer of flexible cable systems used in the construction industry, and CampSwitch is a new firm specializing in digital switching systems. East End Cable is currently trading at $40 per share, and CampSwitch is currently trading at $25 per share. If the takeovers occur, Mr. Richardson estimates that the price of East End Cable will go to $55 per share and CampSwitch will go to $43 per share. At this point in time, Mr. Richardson has identified CampSwitch as the higher-risk alternative. Assume that a client has indicated a willingness to invest a maximum of $50,000.00 in the two companies. The client wants to invest at least $15,000.00 in East End Cable and at least 10,000.00 in CampSwitch. Because of the high risk associated with CampSwitch, Mr. Richardson has recommended that at most $25,000.00 should be…
The Dreamscape Production (DP)) is considering producing a pilot for a comedy series in the hope of selling it to a major television network. The network may decide to reject the series, but it may also decide to purchase the rights to the series for either one or two years. At this point in time, DP may either produce the pilot and wait for the network's decision or transfer the rights for the pilot and series to a competitor for P100 million. DP's decision alternatives and profits (in millions of pesos) are as follows: State of Nature Decision Alternative Reject, S1 1 Year, S2 2 Years, S3 Produce pilot, d1 -100 50 150 Sell to competitor, d2 100 100 100 The probabilities for the state of nature are P(S1) = 0.20, P(S2) = 0.30, and P(S3)…