Operations Management, 12e (Heizer/Render/Munson)

Module A Decision-Making Tools

Section 1 The Decision Process in Operations

1) Analytic decision making is based on logic and considers all available data and possible alternatives.
Answer: TRUE
Diff: 1

2) The last step in the analytic decision process is to clearly define the problem and the factors that
influence it.
Answer: FALSE
Diff: 1

3) Big data refers to numbers larger than 1,600.

Answer: FALSE
Diff: 1

4) Big data refers to huge amounts of data that are often hard to process efficiently or easily.
Answer: TRUE
Diff: 1

5) Which of the following is NOT considered a step in the decision-making process?

A) Clearly define the problem and the factors that influence it.
B) Select the best alternative.
C) Develop specific and measurable objectives.
D) Evaluate each alternative solution based on its merits and drawbacks.
E) Minimize costs whenever possible.
Answer: E
Diff: 2

6) The first step, and a key element, in the decision-making process is to:
A) consult a specialist.
B) clearly define the problem.
C) develop objectives.
D) monitor the results.
E) select the best alternative.
Answer: B
Diff: 1

7) The last step of the decision-making process is to:

A) develop a model.
B) evaluate each alternative.
C) select the best alternative.
D) implement the decision.
E) check the decision with senior management.
Answer: D
Diff: 2

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8) Massive amounts of data:
A) are often collected in production processes.
B) can be automatically collected from web sites and credit cards.
C) require sophisticated tools to store, process, and analyze.
D) are sometimes called "big data."
E) all of the above
Answer: E
Diff: 2

9) Identify, in order, the six steps of analytical decision making.

Answer:
1. Clearly define the problem and factors that influence it.
2. Develop specific and measurable objectives.
3. Develop a model—that is, a relationship between objectives and variables (which are measurable
quantities).
4. Evaluate each alternative solution based on its merits and drawbacks.
5. Select the best alternative.
6. Implement the decision and set a timetable for completion.
Diff: 3

Section 2 Fundamentals of Decision Making

1) A state of nature is an occurrence or a situation over which the decision maker has little or no control.
Answer: TRUE
Diff: 1
Objective: LO A.1 Create a simple decision tree

2) In a decision tree, a square symbol represents a state of nature node.

Answer: FALSE
Diff: 2
Objective: LO A.1 Create a simple decision tree

3) A square node on a decision tree infers that:

A) the node splits into various states of nature, of which only one will occur.
B) there are several alternatives available.
C) the manager must choose an alternative.
D) Both B and C
E) A, B, and C
Answer: D
Diff: 2
AACSB: Reflective thinking
Objective: LO A.1 Create a simple decision tree

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4) The following decision tree has how many state of nature nodes?

A) 0
B) 1
C) 2
D) 3
E) 4
Answer: B
Diff: 2
Objective: LO A.1 Create a simple decision tree

5) In terms of decision theory, an occurrence or situation over which the decision maker has no control is
called a(n):
A) decision under uncertainty.
B) decision tree.
C) state of nature.
D) alternative.
E) EMV.
Answer: C
Diff: 2
Objective: LO A.1 Create a simple decision tree

6) A(n) ________ is an occurrence or situation over which the decision maker has little or no control.
Answer: state of nature
Diff: 1
Objective: LO A.1 Create a simple decision tree

7) The square symbol used in drawing a decision trees represents a(n) ________ node.
Answer: decision
Diff: 1
Key Term: Decision tree
Objective: LO A.1 Create a simple decision tree

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8) In the context of decision-making, define a state of nature.
Answer: A state of nature is an occurrence or situation over which the decision maker has little or no
control.
Diff: 2
Objective: LO A.1 Create a simple decision tree

9) In the context of decision making, define an alternative.

Answer: An alternative is a course of action or strategy that may be chosen by a decision maker.
Diff: 2
Objective: LO A.1 Create a simple decision tree

10) Explain the symbols used in decision tree analysis.

Answer: A decision node from which one or several alternatives may be selected is represented by a
square; a state of nature node out of which states of nature will occur is represented by a circle.
Diff: 2
Objective: LO A.1 Create a simple decision tree

Section 3 Decision Tables

1) An example of a conditional value would be the payoff from selecting a particular alternative when a
particular state of nature occurs.
Answer: TRUE
Diff: 2
Objective: LO A.2 Build a decision table

2) What is a tabular presentation that shows the outcome for each decision alternative under the various
possible states of nature called?
A) isoquant table
B) payback period matrix
C) payoff table
D) feasible region
E) decision tree
Answer: C
Diff: 1
Key Term: Decision table
Objective: LO A.2 Build a decision table

3) What is the outcome of an alternative/state of nature combination called?

A) price
B) conditional value
C) expected value
D) conditional probability
E) conditional expectation
Answer: B
Diff: 2
Objective: LO A.2 Build a decision table

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4) Doing nothing would yield how much profit if favorable market conditions prevail according to the
following profit decision table?

Alternative Favorable market Unfavorable Market

Do Nothing $20,000 -$10,000

A) $5,000
B) $20,000
C) -$10,000
D) $0
E) $10,000
Answer: B
Diff: 1
Key Term: Decision table
Objective: LO A.2 Build a decision table

5) A retailer is deciding how many units of a certain product to stock. The historical probability
distribution of sales for this product is 0 units, 0.2; 1 unit, 0.3; 2 units, 0.4, and 3 units, 0.1. The product
costs $8 per unit and sells for $25 per unit. What is the conditional value for the decision alternative
"Stock 3" and state of nature "Sell 1"?
A) 1.4 units
B) $1 profit
C) $25 profit
D) $-8 profit
E) $23.80 profit
Answer: B
Diff: 2
AACSB: Analytical thinking
Objective: LO A.2 Build a decision table

6) A retailer is deciding how many units of a certain product to stock. The historical probability
distribution of sales for this product is 0 units, 0.2; 1 unit, 0.3; 2 units, 0.4, and 3 units, 0.1. The product
costs $8 per unit and sells for $25 per unit. What is the largest conditional value (profit) in the entire
payoff table for this scenario?
A) $-24 profit
B) $-8 profit
C) $17 profit
D) $51 profit
E) $75 profit
Answer: D
Diff: 2
Key Term: Decision table
AACSB: Analytical thinking
Objective: LO A.2 Build a decision table

7) A(n) ________ is a tabular means of analyzing decision alternatives and states of nature.
Answer: decision table
Diff: 1
Key Term: Decision table
Objective: LO A.2 Build a decision table
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8) What are decision tables?
Answer: Decision tables are a tabular means of analyzing decision alternatives and states of nature.
Diff: 2
Key Term: Decision table
Objective: LO A.2 Build a decision table

9) What is a conditional value?

Answer: It is an outcome of a particular alternative/state of nature combination.
Diff: 2
Objective: LO A.2 Build a decision table

Section 4 Types of Decision-Making Environments

1) If a decision maker can assign probabilities of occurrences to the states of nature, then the decision-
making environment is Decision Making under Uncertainty.
Answer: FALSE
Diff: 2
Objective: LO A.3 Explain when to use each of the three types of decision-making environments

2) The maximax criterion of decision making requires that all decision alternatives have an equal
probability of occurrence.
Answer: FALSE
Diff: 2
Key Term: Maximax
Objective: LO A.3 Explain when to use each of the three types of decision-making environments

3) The maximin criterion is pessimistic, while the maximax criterion is optimistic.

Answer: TRUE
Diff: 1

4) If a decision maker knows for sure which state of nature will occur, he/she is making a decision under
certainty.
Answer: TRUE
Diff: 2
Objective: LO A.3 Explain when to use each of the three types of decision-making environments

5) The expected value with perfect information assumes that all states of nature are equally likely.
Answer: FALSE
Diff: 1
Key Term: Expected value with perfect information (EVwPI)
Objective: LO A.3 Explain when to use each of the three types of decision-making environments

6) An example of expected monetary value would be the payoff from selecting a particular alternative
when a particular state of nature occurs.
Answer: FALSE
Diff: 2
Key Term: Expected monetary value (EMV)
Objective: LO A.4 Calculate an expected monetary value (EMV)

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7) The expected monetary value of a decision alternative is the sum of all possible payoffs from the
alternative, each weighted by the probability of that payoff occurring.
Answer: TRUE
Diff: 1
Key Term: Expected monetary value (EMV)
Objective: LO A.4 Calculate an expected monetary value (EMV)

8) If a decision maker has to make a particular decision only once, expected monetary value is a good
indication of the payoff associated with the decision.
Answer: FALSE
Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Reflective thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

9) The expected value of perfect information is the same as the expected value with perfect information.
Answer: FALSE
Diff: 2
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

10) What decision criterion would be used by an optimistic decision maker solving a problem under
conditions of uncertainty?
A) expected monetary value
B) equally likely
C) maximax
D) maximin
E) minimin
Answer: C
Diff: 2
Key Term: Maximax

11) A decision maker who uses the maximin criterion when solving a problem under conditions of
uncertainty is:
A) an optimist.
B) a pessimist.
C) an economist.
D) an optometrist.
E) making a serious mistake; maximin is not appropriate for conditions of uncertainty.
Answer: B
Diff: 2
Key Term: Maximin

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12) Expected monetary value is most appropriate for problem solving that takes place:
A) when conditions are average.
B) when all states of nature are equally likely.
C) when all alternatives are equally likely.
D) under conditions of uncertainty.
E) under conditions of risk.
Answer: E
Diff: 2
Key Term: Expected monetary value (EMV)
Objective: LO A.3 Explain when to use each of the three types of decision-making environments

13) There are three equally likely states of nature (High, Medium, and Low demand). If the large factory
will post profits of $50,000, $25,000, and - $10,000 under these states of nature, respectively, what is the
EMV of the factory?
A) $50,000
B) $25,000
C) $28,333.33
D) $21,666.67
E) $65,000
Answer: D
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

14) A plant manager wants to know how much he should be willing to pay for perfect market research.
Currently there are two states of nature facing his decision to expand or do nothing. Under favorable
market conditions the manager would make $100,000 for the large plant and $5,000 for the small plant.
Under unfavorable market conditions the large plant would lose $50,000 and the small plant would make
$0. If the two states of nature are equally likely, how much should he pay for perfect information?
A) $0
B) $25,000
C) $50,000
D) $100,000
E) $145,000
Answer: B
Diff: 2
Key Term: Expected value of perfect information (EVPI)
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

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15) The expected value with perfect information:
A) equals EVPI - Maximum EMV.
B) requires that each decision alternative have a known probability of occurrence.
C) is an input into the calculation of the expected value of perfect information.
D) is the average of the maximax and the maximin.
E) none of the above
Answer: C
Diff: 2
Key Term: Expected value with perfect information (EVwPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

16) What is the difference between the expected payoff under perfect information and the maximum
expected payoff under risk?
A) expected monetary value
B) economic order quantity
C) expected value of perfect information
D) PERT
E) expected monetary payoff
Answer: C
Diff: 2
Key Term: Expected value of perfect information (EVPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

17) The likelihood that a decision maker will ever receive a payoff precisely equal to the EMV when
making any one decision is:
A) low (near 0%).
B) high (near 100%).
C) dependent upon the number of alternatives.
D) dependent upon the number of states of nature.
E) none of the above
Answer: A
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Reflective thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

18) The expected value of perfect information (EVPI) is the:

A) payoff for a decision made under perfect information.
B) payoff under minimum risk.
C) average expected payoff.
D) difference between the payoff under perfect information and the payoff under risk.
E) greater of EVwPI and Maximum EMV.
Answer: D
Diff: 2
Key Term: Expected value of perfect information (EVPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

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19) A decision maker using the maximax criterion on the problem below would choose Alternative
________ because the maximum of the row maximums is ________.

States of Nature
1 2 3
Alternative A 50 55 60
Alternative B 30 50 80
Alternative C 70 80 70
Alternative D -100 -10 140

A) A; 60
B) B; 80
C) C; 70
D) D; -100
E) D; 140
Answer: E
Diff: 2
Key Term: Maximax
AACSB: Analytical thinking

20) A decision maker using the maximin criterion on the problem below would choose Alternative
________ because the maximum of the row minimums is ________.

States of Nature
1 2 3
Alternative A 50 55 60
Alternative B 30 50 80
Alternative C 70 80 70
Alternative D -100 -10 140

A) A; 55
B) B; 30
C) C; 70
D) D; 140
E) D; 10
Answer: C
Diff: 2
Key Term: Maximin
AACSB: Analytical thinking

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21) For the following decision table, the highest value for the equally likely criterion is ________; this
occurs with alternative ________.

States of Nature
Alternatives S1 S2
Option 1 $10,000 $30,000
Option 2 $5,000 $45,000
Option 3 $-4,000 $60,000

A) $20,000; Option 1
B) $25,000; Option 2
C) $28,000; Option 3
D) $32,000; Option 3
E) $60,000; Option 3
Answer: C
Diff: 2
Key Term: Equally likely
AACSB: Analytical thinking

22) What is the EMV for Option 1 in the following decision table?

States of Nature
Alternatives S1 S2
p .3 .7
Option 1 15,000 20,000
Option 2 10,000 30,000

A) 15,000
B) 17,000
C) 17,500
D) 18,500
E) 20,000
Answer: D
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

23) The expected value with perfect information is:

A) the maximum EMV for a set of alternatives.
B) the same as the expected value of perfect information.
C) the difference between the payoff under perfect information and the payoff under risk.
D) the expected return obtained when the decision maker knows which state of nature is going to occur
before the decision is made.
E) obtained using conditional probabilities.
Answer: D
Diff: 2
Key Term: Expected value with perfect information (EVwPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)
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24) What is the EMV for Option 2 in the following decision table?

States of Nature
Alternatives S1 S2
p .3 .7
Option 1 15,000 20,000
Option 2 10,000 30,000

A) 10,000
B) 16,000
C) 20,000
D) 24,000
E) 30,000
Answer: D
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

25) What is the EMV for Option 1 in the following decision table?

States of Nature
Alternatives S1 S2
p .4 .6
Option 1 10,000 30,000
Option 2 5,000 45,000
Option 3 -4,000 60,000

A) 10,000
B) 18,000
C) 20,000
D) 22,000
E) 30,000
Answer: D
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

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26) What is the EMV for Option 2 in the following decision table?

States of Nature
Alternatives S1 S2
p .4 .6
Option 1 10,000 30,000
Option 2 5,000 45,000
Option 3 -4,000 60,000

A) 5,000
B) 21,000
C) 25,000
D) 29,000
E) 45,000
Answer: D
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

27) What is the expected value with perfect information of the following decision table?

States of Nature
Alternatives S1 S2
p .4 .6
Option 1 10,000 30,000
Option 2 5,000 45,000
Option 3 -4,000 60,000

A) 5,000
B) 10,000
C) 40,000
D) 60,000
E) 70,000
Answer: C
Diff: 2
Key Term: Expected value with perfect information (EVwPI)
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

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28) What is the EMV for Option 1 in the following decision table?

States of Nature
Alternatives S1 S2
p .6 .4
Option 1 200 300
Option 2 50 350

A) 200
B) 240
C) 250
D) 260
E) 300
Answer: B
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

29) What is the EMV for Option 2 in the following decision table?

States of Nature
Alternatives S1 S2
p .6 .4
Option 1 200 300
Option 2 50 350

A) 50
B) 100
C) 170
D) 200
E) 350
Answer: C
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

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30) What is the expected value with perfect information in the following decision table?

States of Nature
Alternatives S1 S2
p .6 .4
Option 1 200 300
Option 2 50 350

A) 50
B) 200
C) 260
D) 300
E) 350
Answer: C
Diff: 2
Key Term: Expected value with perfect information (EVwPI)
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

31) What is the expected value of perfect information of the following decision table?

States of Nature
Alternatives S1 S2
p .6 .4
Option 1 200 300
Option 2 50 350

A) 0
B) 20
C) 50
D) 150
E) 200
Answer: B
Diff: 3
Key Term: Expected value of perfect information (EVPI)
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

32) ________ is the criterion for decision making under uncertainty that finds an alternative that
maximizes the minimum outcome.
Answer: Maximin
Diff: 2
Key Term: Maximin

33) ________ is the criterion for decision making under uncertainty that assigns equal probability to each
state of nature.
Answer: Equally likely
Diff: 2
Key Term: Equally likely
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34) ________ is the expected payout or value of a variable that has different possible states of nature, each
with an associated probability.
Answer: Expected monetary value or EMV
Diff: 2
Key Term: Expected monetary value (EMV)
Objective: LO A.4 Calculate an expected monetary value (EMV)

35) ________ is the difference between the payoff under perfect information and the payoff under risk.
Answer: Expected value of perfect information or EVPI
Diff: 2
Key Term: Expected value of perfect information (EVPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

36) How is the expected value of perfect information (EVPI) found?

Answer: It is found by taking the expected value with perfect information and subtracting the maximum
expected monetary value (EMV) from it.
Diff: 2
Key Term: Expected value of perfect information (EVPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

37) Identify and describe three methods used for decision making under conditions of uncertainty.
Answer:
(1) Maximax is a criterion that finds an alternative that maximizes the maximum outcome.
(2) Maximin is a criterion that finds an alternative that maximizes the minimum outcome.
(3) Equally likely is a criterion that assigns equal likelihood to each state of nature.
Diff: 2

38) Which decision rule under uncertainty results in an optimistic decision? Why?
Answer: Maximax, because it locates the alternative with the highest possible gain (assumes the best
state of nature will occur).
Diff: 1
Key Term: Maximax

39) If a decision maker is a pessimist, what decision-making criterion is appropriate? Why?

Answer: Maximin assumes that the worst state of nature will happen. This decision making criterion
selects the best of all possible worst outcomes.
Diff: 1
Key Term: Maximin

40) Define expected monetary value (EMV).

Answer: EMV is the expected value or mean return for an alternative if we were to repeat the decision a
large number of times, each time choosing that alternative.
Diff: 2
Key Term: Expected monetary value (EMV)
Objective: LO A.4 Calculate an expected monetary value (EMV)

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41) Describe the meaning of EVPI.
Answer: EVPI is defined as the expected value of perfect information. It is found by taking the expected
value with perfect information and subtracting the maximum expected monetary value (EMV) from it,
and it is the maximum amount that we would be willing to pay for additional (perhaps, perfect)
information.
Diff: 2
Key Term: Expected value of perfect information (EVPI)
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

42) The construction manager for Acme Construction, Inc. must decide whether to build single family
homes, apartments, or condominiums. This is not a product-mix problem, but an all-or-nothing decision.
He will hire workers and rent equipment appropriate for one action only. He estimates annual profits (in
thousands of dollars) will vary with population trends as follows:
Population grows Population grows
Dwelling type Population steady slowly rapidly
Single family $100 $90 $70
Apartments 50 170 90
Condominiums -20 100 220

a. If he uses the maximin criterion, which type of dwellings will he choose to build? Show your
supporting calculations.
b. If he uses the equally likely criterion, which kind of dwellings will he choose to build? Show your
supporting calculations.
c. If the construction manager were an optimist, what criterion would he choose? What would be the
choice of dwelling for that criterion? Show your supporting calculations.
Answer:
(a) The pessimistic maximin criterion assumes the worst state of nature will occur and selects the action
associated with the best of these worst outcomes. For this problem, the "worsts" for each action are Single
family = $70, Apartments = $50, and Condominiums = -20. The best of the worsts is $70, so the manager
should choose to build single family homes.
(b) The equally likely criterion calculates the simple average of each action; the results are Single family =
$86.7, Apartments = $103.3, and Condominiums = $100. The manager should select the action associated
with the largest of these values, and build apartments.
(c) The optimistic criterion is maximax, which assumes that the best outcome will occur for each action.
The best outcomes are Single family = $100, Apartments = $170, and Condominiums = $220. The manager
chooses the action associated with the best of the bests, or Condominiums.
Diff: 2
AACSB: Analytical thinking

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43) An operations manager's staff has compiled the information below for four manufacturing
alternatives (A, B, C, and D) that vary by production technology and the capacity of the machinery. All
choices enable the same level of total production and have the same lifetime. The four states of nature
represent four levels of consumer acceptance of the firm's products. Values in the table are net present
value of future profits in millions of dollars.

States of Nature
1 2 3 4
Alternative A 50 55 60 65
Alternative B 30 50 80 130
Alternative C 70 80 70 65
Alternative D -100 -10 150 220

a. Assuming a maximax strategy, which alternative would be chosen?

b. If maximin were used, which would be chosen?
c. If the states of nature were equally likely, which alternative should be chosen?
Answer:
(a) The maximax strategy selects the best of the best, which is $220. This happens when Alternative D is
selected.
(b) The maximin strategy selects the best of the worsts; the worsts are A = 50, B = 30, C = 65, and D = -100.
The best of these is 65, associated with Alternative C.
(c) The averages for the four alternatives are A = 57.5, B = 72.5, C = 71.25, and D = 65. The highest of these
is 72.5, associated with Alternative B.
Diff: 2
AACSB: Analytical thinking

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44) An operations manager's staff has compiled the information below for four manufacturing
alternatives (E, F, G, and H) that vary by production technology and the capacity of the machinery. All
choices enable the same level of total production and have the same lifetime. The four states of nature
represent four levels of consumer acceptance of the firm's products. Values in the table are net present
value of future profits in millions of dollars. Forecasts indicate that there is a 0.1 probability of acceptance
level 1, 0.2 chance of acceptance level 2, 0.4 chance of acceptance level 3, and 0.3 change of acceptance
level 4.

States of Nature
1 2 3 4
Alternative E 50 50 70 60
Alternative F 30 50 80 130
Alternative G 70 80 70 60
Alternative H -140 -10 150 220

Using the criterion of expected monetary value, which production alternative should be chosen?
Answer: The expected values are:
E = .1(50) + .2(50) + .4(70) + .3(60) = 5 + 10 + 28 + 18 = 61
F = .1(30) + .2(50) + .4(80) + .3(130) = 3 + 10 + 32 + 39 = 84
G = .1(70) + .2(80) + .4(70) + .3(60) = 7 + 16 + 28 + 18 = 69
H = .1(-140) + .2(-10) + .4(150) + .3(220) = -14 -2 + 60 + 66 = 110
The highest of these occurs with production alternative H.
Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

45) A toy manufacturer has three different mechanisms that can be installed in a doll that it sells. The
different mechanisms have three different setup costs (overheads) and variable costs and, therefore, the
profit from the dolls is dependent on the volume of sales. The anticipated payoffs are as follows.

Light Demand Moderate Demand Heavy Demand

Probability 0.25 0.45 0.3
Wind-up action $325,000 $190,000 $170,000
Pneumatic action $300,000 $420,000 $400,000
Electrical action -$400,000 $240,000 $800,000

a. What is the EMV of each decision alternative?

b. Which action should be selected?
c. What is the expected value with perfect information?
d. What is the expected value of perfect information?
Answer:
(a) Wind-up = .25($325,000) + .45($190,000) + .3($170,000) = $217,750; Pneumatic = .25($300,000) + .
45($420,000) + .3($400,000) = $384,000; and Electrical = .25(-$400,000) + .45($240,000) + .3($800,000) =
$248,000. (b) Pneumatic has the best EMV, at $384,000. (c) EVwPI is .25($325,000) + .45($420,000) + .
3($800,000) = $510,250; (d) EVPI = $510,250 - $384,000 = $126,250.
Diff: 3
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)
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46) Steve Gentry, the operations manager of Baja Fabricators, wants to purchase a new profiling machine
(it cuts compound angles on the ends of large structural pipes used in the fabrication yard). However,
because the price of crude oil is depressed, the market for such equipment is down. Steve believes that
the market will improve in the near future and that the company should expand its capacity. The table
below displays the three equipment options he is currently considering, and the profit he expects each
one to yield over a two-year period. The consensus forecast at Baja is that there is about a 30% probability
that the market will pick up "soon" (within 3 to 6 months) and a 70% probability that the improvement
will come "later" (in 9 to 12 months, perhaps longer).

Profit from Capacity Investment (in Dollars)

Market picks up "soon" Market picks up "later"
Equipment Option p = 0.30 p = 0.70
Manual Machine -120,000 210,000
NC Machine 140,000 160,000
CNC Machine 200,000 -200,000

a. Calculate the expected monetary value of each decision alternative.

b. Which equipment option should Steve take?
Answer:
(a) The expected monetary values are: "Manual machine" $111,000, "NC Machine" $154,000, and "CNC
Machine" -$80,000.
(b) Based upon the EMV criterion, Baja should purchase an NC machine.
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

20
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47) Miles is considering buying a new pickup truck for his lawn service firm. The economy in town seems
to be growing, and he is wondering whether he should opt for a subcompact, compact, or full-size pickup
truck. The smaller truck would have better fuel economy, but would sacrifice capacity and some
durability. A friend at the Bureau of Economic Research told him that there is a 30% chance of lower gas
prices in his area this year, a 20% chance of higher gas prices, and a 50% chance that gas prices will stay
roughly unchanged. Based on this information, Miles has developed a decision table that indicates the
profit amount he would end up with after a year for each combination of truck and gas prices.

States of Nature
Alternatives Lower gas prices Gas prices unchanged Higher gas prices
Probability .3 .5 .2
Subcompact $16,000 $21,000 $23,000
Compact $15,000 $20,000 $22,000
Full size $18,000 $19,000 $6,000

Calculate the expected monetary value for each decision alternative. Which decision yields the highest
EMV?
Answer: The expected values are: subcompact $19,900, compact $18,900, and full size $16,100. The
highest EMV is that of the subcompact truck.
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

48) Earl Shell owns his own Sno-Cone business and lives 30 miles from a beach resort. The sale of Sno-
Cones is highly dependent upon his location and upon the weather. At the resort, he will profit $110 per
day in fair weather, $20 per day in foul weather. At home, he will profit $70 in fair weather, $50 in foul
weather. Assume that on any particular day, the weather service suggests a 60% chance of fair weather.
a. Construct Earl's payoff table.
b. What decision is recommended by the expected monetary value criterion?
c. What is the EVPI?
Answer:
(a) The payoff table is

Profit Fair weather Foul weather

Probability = 0.6 Probability = .4
Sell at the resort 110 20
Sell at home 70 50

(b) the EMV for sell at the resort = .6(110) + .4(20) = 74; The EMV for sell at home = .6(70) + .3(50) = 62. The
better value is $74, so Earl should sell at the resort.
(c) EVwPI = .6(110) + .4(50) = $86; EVPI = $86 - $74 = $12.
Diff: 3
AACSB: Analytical thinking
Objective: LO A.5 Compute the expected value of perfect information (EVPI)

21
Copyright © 2017 Pearson Education, Inc.
49) The campus bookstore sells stadium blankets embroidered with the university crest. The blankets
must be purchased in bundles of one dozen each. Each blanket in the bundle costs $65, and will sell for
$90. Blankets unsold by homecoming will be clearance priced at $20. The bookstore estimates that
demand patterns will follow the table below.
a. Build the decision table.
b. What is the maximum expected monetary value?
c. How many bundles should be purchased?

Demand level Probability

1 bundle 10 percent
2 bundles 30 percent
3 bundles 50 percent
4 bundles 10 percent

Answer: (a) See the table below; (b) the maximum expected value is $516; (c) the bookstore should order
2 bundles.

Profit Demand 1 Demand 2 Demand 3 Demand 4 EMV

Probability 0.1 0.3 0.5 0.1
Order 1 300 300 300 300 300
Order 2 -240 600 600 600 Maximum 516
Order 3 -780 60 900 900 480
Order 4 -1320 -480 360 1200 24

Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

22
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50) Daily sales of bread by Salvador Monella's Baking Company follow the historical pattern shown in the
table below. It costs the bakery 50 cents to produce a loaf of bread, which sells for 95 cents. Any bread
unsold at the end of the day is sold to the parish jail for 25 cents per loaf. Construct the decision table of
conditional payoffs. How many loaves should Sal bake each day in order to maximize contribution?

Demand 400 500 600 700 800

Probability .20 .20 .40 .15 .05

Answer: The Excel OM decision table and solution appear below. The best expected value is $228, which
occurs with the decision to bake 600 loaves.

Profit Sell 400 Sell 500 Sell 600 Sell 700 Sell 800 EMV
Probability 0.2 0.2 0.4 0.15 0.05
Bake 400 180 180 180 180 180 180
Bake 500 155 225 225 225 225 211
Bake 600 130 200 270 270 270 Maximum 228
Bake 700 105 175 245 315 315 217
Bake 800 80 150 220 290 360 195.5

Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

23
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51) The campus bookstore sells highlighters that it purchases by the case. Cost per case, including
shipping and handling, is $200. Revenue per case is $350. Any cases unsold will be discounted and sold at
$175. The bookstore has estimated that demand will follow the pattern below

Demand level Probability

10 cases 20 percent
11 cases 20 percent
12 cases 40 percent
13 cases 15 percent
14 cases 5 percent

a. Construct the bookstore's payoff table.

b. How many cases should the bookstore stock in order to maximize expected profit?
c. How would your answer differ if the clearance price were not $175 per case but $225 per case? (It is
not necessary to re-solve the problem to answer this.)
Answer:
(a) The Excel OM table is below.
(b) The highest EMV is 1705, from stocking 13 cases.
(c) If the clearance price exceeds the case cost, there will be no disincentive to stocking the maximum
demand level, 14 cases.

Demand Demand Demand Demand Demand

Profit 10 11 12 13 14 EMV
Probability 0.2 0.2 0.4 0.15 0.05
Stock 10 1500 1500 1500 1500 1500 1500
Stock 11 1475 1650 1650 1650 1650 1615
Stock 12 1450 1625 1800 1800 1800 1695
Stock 13 1425 1600 1775 1950 1950 Maximum 1705
Stock 14 1400 1575 1750 1925 2100 1688.75

Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

52) The EMV of a decision with three states of nature is $33,000. If the profit/value under the states of
nature A, B, and C is $10,000, $20,000, and $50,000, respectively, and states B and C have equal
probabilities, determine the likelihood of state of nature A.
Answer: Let Y = the probability of state of nature B (and C)
Then the probability of state of nature A = 1 - 2Y
EMV = 10,000(1 - 2Y) + 20,000Y + 50,000Y = 33,000
70,000Y - 20,000Y = 23,000
50,000Y = 23,000
Y = .46
likelihood of state of nature A = 1 - 2(.46) = .08 or 8%
Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)
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53) The EMV of a decision with three states of nature is $50. If the profit/value of A is 1/3 of B and B is 1/3
of C, determine the profit from A if all three states of nature are equally likely to occur.
Answer: The total payoff is simply the average of the three payoffs or 1/9 + 1/3 + 1 = 13/27 if the value of
C is 1. Solving for 13/27 ∗ C = 50 gives C = $103.85. Thus A = $11.54.
Diff: 3
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

54) Suppose a manufacturing plant is considering three options for expansion. The first one is to expand
into a new plant (large), the second to add on third-shift to the daily schedule (medium), and the third to
do nothing (small). There are three possibilities for demand. These are high, medium, and low with each
having an equal likelihood of occurring. Suppose that the profits for the expansion plans are as follows
(respective to high, medium, low demand). The large expansion profits are $100000, $10000, -$10000, the
medium expansion choice $40000, $40000, $5000 and the small expansion choice $15000, $15000, $15000.
Calculate the EMV of each choice. Which of the expansion plans should the manager choose?
Answer: EMV large expansion is .33(100000) + .33(10000) + .33(-10000) = $33,333.33
EMV medium expansion is .33(40000) + .33 (40000) + .33(5000) = $28,333.33
EMV small expansion is $15,000
The plant manager should choose the large expansion.
Diff: 2
Key Term: Expected monetary value (EMV)
AACSB: Analytical thinking
Objective: LO A.4 Calculate an expected monetary value (EMV)

Section 5 Decision Trees

1) Decision trees and decision tables can both solve problems requiring a single decision, but decision
tables are the preferred method when a sequence of decisions is involved.
Answer: FALSE
Diff: 1
Objective: LO A.7 Create a decision tree with sequential decisions

2) In a decision tree, the expected monetary values are computed by working from right to left.
Answer: TRUE
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

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3) When solving decision trees, what phrase represents the act of dropping an alternative from
consideration because it is less favorable than another available option?
A) cut the leaf
B) open the hatch
C) shake the tree
D) punt the ball
E) prune the branch
Answer: E
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

4) Decision trees:
A) give more accurate solutions than decision tables.
B) give less accurate solutions than decision tables.
C) are especially powerful when a sequence of decisions must be made.
D) are rarely used because one needs specialized software to graph them.
E) are too complex to be used by decision makers.
Answer: C
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

5) A decision tree is a(n):

A) algebraic representation of alternatives and states of nature.
B) behavioral representation of alternatives and states of nature.
C) matrix representation of alternatives and states of nature.
D) graphical representation of alternatives and states of nature.
E) tabular representation of alternatives and states of nature.
Answer: D
Diff: 1
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

6) All EXCEPT which of the following steps are taken to analyze problems with decision trees?
A) Define the problem.
B) Structure or draw the decision tree.
C) Assign probabilities to the alternatives.
D) Estimate payoffs for each possible alternative/state of nature combination.
E) Solve the problem by computing expected monetary values for each state-of-nature node.
Answer: C
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

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7) A primary advantage of decision trees compared to decision tables is that decision trees:
A) are more accurate.
B) are faster.
C) are smaller.
D) are cheaper.
E) can be used for sequential problems.
Answer: E
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

8) A problem that involves a sequence of decisions:

A) cannot be analyzed with expected monetary value.
B) can be better analyzed with a decision tree than by a decision table.
C) must be analyzed in the same order that the decisions are made.
D) cannot be analyzed with decision tree software.
E) can only be analyzed using decision making under certainty.
Answer: B
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

9) A(n) ________ is a graphical means of analyzing decision alternatives and states of nature.
Answer: decision tree
Diff: 1
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

10) A branch of a decision tree that is less favorable than other available options may be ________.
Answer: pruned or dropped
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

11) What limitation(s) do decision trees overcome compared to decision tables?

Answer: Decision trees work better when a sequence of decisions must be made.
Diff: 2
Key Term: Decision tree
Objective: LO A.7 Create a decision tree with sequential decisions

27
Copyright © 2017 Pearson Education, Inc.
12) A toy manufacturer makes stuffed kittens and puppies that have relatively lifelike motions. There are
three different mechanisms which can be installed in these "pets." These toys will sell for the same price
regardless of the mechanism installed, but each mechanism has its own variable cost and setup cost.
Profit, therefore, is dependent upon the choice of mechanism and upon the level of demand. The
manufacturer has in hand a forecast of demand that suggests a 0.2 probability of light demand, a 0.45
probability of moderate demand, and a probability of 0.35 of heavy demand. Payoffs for each mechanism-
demand combination appear in the table below.

Demand Wind-up action Pneumatic action Electronic action

Light $250,000 $90,000 -$100,000
Moderate 400,000 440,000 400,000
Heavy 650,000 740,000 780,000

Construct the appropriate decision tree to analyze this problem. Use standard symbols for the tree.
Analyze the tree to select the optimal decision for the manufacturer.
Answer:

The best choice is Pneumatic, $475,000.

Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

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13) A local business owner is a bit uncertain of the demand forecast, and he is timidly approaching the
capacity decision for a business he is about to open. Here's how he describes the decisions that confront
him over the next two years.

"First, I have to choose between building a large plant initially and building a small one that has room to
expand. Or I could rent now and decide whether to build next year. That one, too, could be the large
version or the small. If I build small, then after one year, I can review how good business was, and decide
whether to expand. If I build large, there is no further option to enlarge."

Do not concern yourself with probabilities or payoff values. Simply draw the tree that illustrates the
manager's decision alternatives and the chance events that go along with them. Use standard symbols for
decision tree construction, and label all parts of your diagram carefully. To simplify, assume that business
in the first year, and in the second, can be only "good" or "bad."
Answer:

29
Copyright © 2017 Pearson Education, Inc.
Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.7 Create a decision tree with sequential decisions

30
Copyright © 2017 Pearson Education, Inc.
14) Miles is considering buying a new pickup truck for his lawn service firm. The economy in town seems
to be growing, and he is wondering whether he should opt for a subcompact, compact, or full-size pickup
truck. The smaller truck would have better fuel economy, but would sacrifice capacity and some
durability. A friend at the Bureau of Economic Research told him that there is a 30% chance of lower gas
prices in his area this year, a 20% chance of higher gas prices, and a 50% chance that gas prices will stay
roughly unchanged. Based on this information, Miles has developed a decision table that indicates the
profit amount he would end up with after a year for each combination of truck and gas prices. Develop a
decision tree for this situation and indicate which type of truck he should select.

States of Nature
Alternatives Lower gas prices Gas prices unchanged Higher gas prices
Probability .3 .5 .2
Subcompact 16,000 19,000 21,000
Compact 15,000 20,000 22,000
Full size 24,000 19,000 6,000

Answer: The tree appears in the drawing below. The highest expected value decision alternative is the
compact truck, at $18,900, as shown in the POM for Windows solution.

31
Copyright © 2017 Pearson Education, Inc.
Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

32
Copyright © 2017 Pearson Education, Inc.
15) Earl Shell owns his own Sno-Cone business and lives 30 miles from a beach resort. The sale of Sno-
Cones is highly dependent upon his location and upon the weather. At the resort, he will profit $120 per
day in fair weather, $10 per day in bad weather. At home, he will profit $70 in fair weather, $55 in bad
weather. Assume that on any particular day, the weather service suggests a 40% chance of foul weather.
a. Construct Earl's decision tree.
b. What decision is recommended by the expected value criterion?
Answer: Resort has a higher EMV ($76) than Home

Diff: 2
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

33
Copyright © 2017 Pearson Education, Inc.
16) Bratt's Bed and Breakfast, in a small historic New England town, must decide how to subdivide
(remodel) the large old home that will become an inn. There are three alternatives: Option A would
modernize all baths and combine rooms, leaving the inn with four suites, each suitable for two to four
adults. Option B would modernize only the second floor; the results would be six suites, four for two to
four adults, and two for two adults only. Option C (the status quo option) leaves all walls intact. In this
case, there are eight rooms available, but only two are suitable for four adults, and four rooms will not
have private baths. Below are the details of profit and demand patterns that will accompany each option.
Which option has the highest expected value?

Annual profit under various demand

patterns
Capacity p Average p
A (Modernize all) $90,000 .5 $25,000 .5
B (Modernize 2nd) $80,000 .4 $70,000 .6
C (Status Quo) $60,000 .3 $55,000 .7

Answer: Branch 2, which represents Option B-Modernize 2nd floor, has the highest expected value,
$74,000. This cannot be done as a decision table. POM for Windows solution follows.

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Copyright © 2017 Pearson Education, Inc.
Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

17) A do-it-yourself homeowner is installing a new toilet. While installing the toilet he must decide on
what kind of connecting pipe he will install to the water supply. There are two available options, one that
has a shut-off valve in case of a leak and a cheaper one without the shut-off valve. Suppose that the shut-
off valve pipe costs an extra ten dollars and that the homeowner must buy one of the two.
a. Draw a decision tree for this scenario, labeling the cost of a leak as X and the chance of a leak as P.
b. If the chance of a leak causing household damage is 1%, at what $ amount of household damage is
the owner neutral on which pipe to buy?
c. If the cost of a leak would be $10,000 what is the maximum % chance to leak at which the homeowner
would prefer to buy the cheaper pipe?
d. If the cost of a leak is $1,000 and the chance to flood .1% which pipe should the homeowner buy?
Answer:
a.

b. EMV of part B for the cheap pipe is .99(0) + .01(X), EMV for the leak-proof pipe is 10, set these equal
to find the neutral value of X so .01X = 10 and X = $1000
c. EMV of part C for the cheap pipe is (1 - P)(0) + (P)(10,000), EMV for the leak-proof pipe is 10. Set
these equal to find the maximum percent, so 10,000P = 10 with P = .001
d. EMV of the cheap pipe is .999(0) + .001(1,000) which = $1 and the EMV of the leak-proof pipe is 10, so
the homeowner should buy the cheaper pipe.
Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

35
Copyright © 2017 Pearson Education, Inc.
18) A poker player is considering three different options after his opponent bet 200 before him. If the
player folds, he will lose instantly. If the player calls, he figures he will win half the time. If he raises, he
figures that the opposing player will not re-raise him, but rather will either call or fold. He figures the
opposing player will call only ¼ of the time, folding the other ¾ of the time. If the opposing player calls
his raise, he figures he will never win. The pot size is 1,000 (including the opposing player's bet).
a. Draw a decision tree for this scenario including the information provided in part b.
b. Suppose that the player is thinking of raising to $400 (he will put in 200 to match the opponent's bet
and another 200 as a raise, his opponent would then have to put in 200 more to call the raise). Is this the
best option or should he instead call or fold?
c. At what raise size is the player's EMV of a raise equivalent to simply calling?
Answer:
a.

b. EMV of a fold is 0, EMV of a call is .5(1000) - .5(200) = 400, EMV of the raise is .75(1000) - .25 (400) =
650. The player should raise, not call or fold.
c. EMV of a call is 400 from above, EMV of a raise is .75(1000) - .25(Raise Size). Setting these equal so 400
= .75(1000) - .25(Raise size) the raise size comes out to 1400.
Diff: 3
Key Term: Decision tree
AACSB: Analytical thinking
Objective: LO A.6 Evaluate the nodes in a decision tree

36
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