Exercise of Decision Tree

Revising Judgments in the Light

of New Information
Decision Making


CASE EXERCISE 1
Stock Retailer
A retailer has to decide whether to hold a large
or a small stock of a product for the coming
summer season. A payoff table for the courses
of action and outcomes is shown below:

(Profits)
Decision Low sales High sales
Hold small stocks $80 000 $140 000
Hold large stocks $20 000 $220 000
Stock Retailer
The retailer estimates that there is a 0.4
probability that sales will be low and a 0.6
probability that they will be high. What level of
stocks should he hold?

Stock Retailer New Information
Before implementing his decision the retailer
receives a sales forecast which suggests that sales
will be high. In the past when sales turned out to be
high the forecast had correctly predicted high sales
on 75% of occasions. However, in seasons when
sales turned out to be low the forecast had wrongly
predicted high sales on 20% of occasions. The
underlying market conditions are thought to be
stable enough for these results to provide an
accurate guide to the reliability of the latest
forecast. Should the retailer change his mind in the
light of the forecast?
DECISION TREE?
CASE EXERCISE 2
Production Strategy
The managers of a soft drinks company are
planning their production strategy for next summer.
The demand for their products is closely linked to
the weather, and an analysis of weather records
suggests the following probability distribution for
the June to August period:
Weather conditions Probability
Hot and dry 0.3
Mixed 0.5
Cold and wet 0.2
1
Production Strategy
The table below shows the estimated profits
($000s) which will accrue for the different
production strategies and weather conditions:
Weather conditions
Production strategy Hot & dry Mixed Cold & wet
Plan for high sales 400 100 -100
Plan for medium sales 200 180 70
Plan for low sales 110 100 90
Production Strategy
On the basis of the information given,
determine the course of action which will
maximize expected profits!
Production Strategy
A long-range weather forecast suggests that next summers
weather conditions will, in general, be cold and wet. The
reliability of the forecast is indicated by the following
probabilities which are based on past performance:
p(cold, wet conditions forecast when weather will be hot
and dry) = 0.3
p(cold, wet conditions forecast when weather will be
mixed) = 0.4
p(cold, wet conditions forecast when weather will be cold
and wet) = 0.6
In the light of the long-range weather forecast, should the
company change from the course of action you recommended
before?

CASE EXERCISE 3
North Holt Farm
A year ago a major potato producer suffered
serious losses when a virus affected the crop at
the companys North Holt farm. Since then,
steps have been taken to eradicate the virus
from the soil and the specialist who directed
these operations estimates, on the basis of
preliminary evidence, that there is a 70% chance
that the eradication program has been
successful.
North Holt Farm
The manager of the farm now has to decide on his policy
for the coming season and he has identified two
options:
He could go ahead and plant a full crop of potatoes. If
the virus is still present an estimated net loss of
$20000 will be incurred. However, if the virus is
absent, an estimated net return of $90 000 will be
earned.
He could avoid planting potatoes at all and turn the
entire acreage over to the alternative crop. This would
almost certainly lead to net returns of $30000.
North Holt Farm
The manager is now informed that Ceres
Laboratories could carry out a test on the farm
which will indicate whether or not the virus is still
present in the soil. The test itself would cost
$10000. Suppose that, after making further
enquiries, the farm manager discovers that the
Ceres test is not perfectly reliable. If the virus is still
present in the soil the test has only a 90% chance of
detecting it, while if the virus has been eliminated
there is a 20% chance that the test will incorrectly
indicate its presence.
THANK YOU