STUDENT SOLUTION MANUAL

Business Statistics in Practice, Third Canadian Edition

by
Bowerman, Aitken Schermer, Johnson, & OConnell

CHAPTER 15: Decision Theory

15.1

[LO 1]
Certainty: We know for certain which state of nature will occur.
Uncertainty: No information about the likelihood of states of nature.
Risk: Probability of each state of nature can be estimated.

15.3

[LO 3]
Reverse the order of the decision and the uncertainty node. The value of perfect information is
the difference (gain) between the expected values.

15.5

[LO 1]
Minimum payoffs: Large = $4 M, Medium = $7M, Small = $10M
Maximum payoff of the minimums: Small facility at $10M

15.7

[LO 1]
a.

Expected Monetary Value (Small) = (10)(.3) + (10)(.5) + (10)(.2) = $10M

EMV(Medium) = (7)(.3) + (12)(.5) + (12)(.2) = $10.5M
EMV(Large) = (4)(.3) + (2)(.5) + (16)(.2) = $3M

b.
15.9

15.11

Best alternative: Medium facility

[LO 3]
a.

EVcertainty: (10)(.3) + (12)(.5) + (16)(.2) = $12.2M

b.

EVPI = EVcertainty EMV = 12.2 10.5 = $1.7M

[LO 3]
a.

Expected Monetary Value (Loc A) = (1)(.6) + (14)(.4) = $6.2M

EMV(Loc B) = (2)(.6) + (10)(.4) = $5.2M
Student Solution Manual
Business Statistics in Practice, Third Canadian Edition
2014 McGraw-Hill Ryerson Limited. All rights reserved.
1

Chapter 15 Decision Theory

EMV(Loc C) = (4)(.6) + (6)(.4) = $4.8M
b.

Location A

c.

EVcertainty: (4)(.6) + (14)(.4) = $8.0M

EVPI = EVcertainty EMV = 8.0 6.2 = $1.8M

15.13

[LO 2]
a.

Expected Monetary Value (Subcontract) = (1)(.4) + (1.3)(.5) + (1.8)(.1) = $1.23M

EMV(Expand) = (1.5)(.4) + (1.6)(.5) + (1.7)(.1) = $1.57M
EMV(Build) = (1.4)(.4) + (1.1)(.5) + (2.4)(.1) = $1.35M

b.
15.15

15.17

Expand

[LO 5]
a.

expected value of the expected payoff

b.

expected payoff of alternative chosen using the expected monetary value criterion with
the prior probabilities

c.

expected payoff of sampling minus the expected payoff of no sampling

d.

difference between the EVIS and the cost of sampling

[LO 5]

Up

Flat

Down

HighRisk

1500

100

1000

Low Risk

1000

200

100

500

500

500

Savings Acct

Student Solution Manual

Business Statistics in Practice, Third Canadian Edition
2014 McGraw-Hill Ryerson Limited. All rights reserved.
2

Chapter 15 Decision Theory

15.19

[LO 5]
Prior Probabilities: .50, .30, .20
Conditional Probabilities:
economist says up
economist says flat
economist says down

Up
.8
.1
.1

Flat
.15
.70
.15

Down
.2
.2
.6

Up
.400
.050
.050

Flat
.045
.210
.045

Down
.040
.040
.120

Up
.8247
.1667
.2326

Flat
.0928
.7000
.2093

Down
.0825
.1333
.5581

Joint Probabilities:
economist says up
economist says flat
economist says down

Total
.485
.300
.215

Revised Probabilities:
economist says up
economist says flat
economist says down

15.21

15.23

a.

P(economist says up) = (.5)(.8) + (.15)(.3) + (.2)(.2) = .485

Posterior Probabilities: .8247, .0928, .0825

b.

P(economist says flat) = (.5)(.1) + (.7)(.3) + (.2)(.2) = .300

Posterior Probabilities: .1667, .7000, .1333

c.

P(economist says flat) = (.5)(.1) + (.15)(.3) + (.6)(.2) = .215

Posterior Probabilities: .2326, .2093, .5581

d.

Decision tree not listed in this manual.

[LO 5]
a.

EPS = (.485)(1163.92) + (.3)(500) + (.215)(500) = 821.96

b.

EPNS = 580

c.

EVSI = 821.96 580 = 241.96

d.

Max amount to pay economist for advice: 242.00

[LO 1]
Payoff Table:

Not Send Eng.

In
Out
15,000 12,000

Send Eng.

14,500 14,500

Student Solution Manual

Business Statistics in Practice, Third Canadian Edition
2014 McGraw-Hill Ryerson Limited. All rights reserved.
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Chapter 15 Decision Theory

15.27

[LO 5]
a. Test equipment reads in:
EMV(Not Send) = (15000)(.9863) + (12000)(.0137) = 14958.90
EMV(Send) = 14500
Choose: do not send engineer
b.

15.29

Test equipment reads out:

EMV(Not Send) = (15000)(.6667) + (12000)(.3333) = 14000
EMV(Send) = 14500
Choose: send engineer

[LO 4]
Utility is a measure of monetary value based on an individuals attitude toward risk.

15.33

15.35

[LO 1]
a.

research project should continue:

(.7)(23) + (.3)(2) = $15.5

b.

should be licensed: slightly better return

License: $23
Develop: (.25)(43) + (.55)(21) + (.2)(3) = $22.9

[LO 1, 4]
Prior Probabilities: .6, .4
Conditional Probabilities:
High
Low
favorable
.9
.2
unfavorable .1
.8
Joint Probabilities:
High
favorable
.54
unfavorable .06

Low
.08
.32

Revised Probabilities:
High
favorable
.871
unfavorable .158

Low
.129
.842

a.

Total
.62
.38

Favorable:
EMV(small) = (40)(.129) + (55)(.871) = 53.065
EMV(large) = (50)(.129) + (70)(.871) = 67.42
Choose: build large
Student Solution Manual
Business Statistics in Practice, Third Canadian Edition
2014 McGraw-Hill Ryerson Limited. All rights reserved.
4

Chapter 15 Decision Theory

Unfavorable:
EMV(small) = (40)(.842) + (55)(.158) = 42.37
EMV(large) = (50)(.842) + (70)(.158) = 53.16
Choose: build large
b.

15.37

EPS = (67.42)(.62) + (53.16)(.38) = 62

EPNS = (50)(.4) + (70)(.6) = 62
EVSI = 62 62 = 0
Max amount to pay economist for advice: 0

[LO 1]
a.

Maximax: Relocate, highest of the highest payoffs of $5M

b.

Maximin: Renew lease, highest payoff of the minimum payoffs possible.

Student Solution Manual

Business Statistics in Practice, Third Canadian Edition
2014 McGraw-Hill Ryerson Limited. All rights reserved.
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