Narsee Monjee Institute of Management Studies

Decision Analysis and Modelling MBA Core : Trimester III 2018

Title: Decision Tree

1. The Oil India Corporation (OIC) is considering whether to go for an offshore oil drilling contract to be
awarded in Bombay High. If OIC bid, value would be Rs 600 million with a 65% chance of gaining the
contract. The OIC may set up a new drilling operation or move already existing operation, which has proved
successful, to a new site. The probability of success and expected returns are a follows:
Outcome New drilling operation Existing Operation
Probability Expected revenue Probability Expected revenue
(Rs million) (Rs million)
Success 0.75 800 0.85 700
Failure 0.25 200 0.15 350
In the Corporation do not bid or lose the contract, the can use Rs 600 million to modernise their operation.
This would result in a return of either 5 percent or 8 percent on the sum invested with probabilities 0.45 and
0.55. (Assume that all costs and revenue have been discounted to present value.)

(a) Construct a decision tree for the problem showing clearly the courses of action.

(b) By applying an appropriate decision criterion recommend whether or not the Oil India Corporation should
bid the contract.

2. Motor City Auto company must decide whether or not to introduce a new car, which features a radically
new pollution control system. They must also decide whether the results of test marketing a limited
production show promise or not. The test marketing of limited production will cost Rs 4 crores.
The marketing department has made the following estimations:
(a) If the new car achieves high acceptance by the public, company profits will increase by Rs
25 crores.
(b) Low acceptance will reduce company profits by Rs 15 crores.
(c) Not introducing the car will not affect the profit.
The probabilities for the different outcomes through alternate actions are as follows:
(a)If test marketing is not done, the possibility of high acceptance is 0.40.
(b)The assumed probability for a favourable result from test marketing is 0.50.
©The conditional probability for high acceptance after a favourable result is 0.64.
(d)If the car is introduced in spite of unfavourable test marketing results, the probability of low acceptance is
0.84.
Construct the decision tree and determine the optimal course of action.

3.A manufacturing company has to select one of the two products A and B for manufacturing. Product A
requires an investment of Rs 20,000 and Product B Rs40,000. Market research survey, which shows high,
medium, and low demands with corresponding probabilities and sales earnings in thousands of rupees, for the
two products is given in table below.

Market Probability Sales

A B A B
High 0.4 0.3 50 80
Medium 0.3 0.5 30 60
Low 0.3 0.2 10 5
Construct an appropriate decision tree. What decision should the company take?

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4. The daily demand for bread loaves in the city can assume one of the following values:
3400,3600,3800,4000 with probabilities 0.18,0.12,0.20,0.50 respectively. If the stockist stocks more than the
requirement, he has a salvage value of Rs 17 per bread loaf. Assuming that a loaf of bread costs him Rs 18,
which he can sell at rs 20, find the optimum stock level using the decision tree. There is no opportunity loss
cost.

5.A financial advisor has recommended two possible mutual funds for investment: Fund A and Fund B. The
return that will be achieved by each of these funds depends on whether the economy is good, fair or poor. A
payoff table (with the anount in dollars) has been constructed to illustrate these situations as shown in table
below.

Investment Economy
Good Fair Poor
Fund A 10000 2000 -5000
Fund B 6000 4000 0
Probability 0.2 0.3 0.5

a.Draw the decision tree to represent this situation.

b.Perform the necessary calculations to determine which of the two mutual funds is better. Which one should
you choose to maximize the expected value?

6. Mr Anish has to decide whether or not to drill a well on his farm. In his town, only 40% of the
wells drilled were successful at 200 feet of depth. Some of the farmers who did not get water at 200
feet, drillked further upto 250 feet but only 20% struck water at 250 feet. Cost of drilling is rs 50 per
foot. Mr. anish estrimated that he would pay rs 18000 during a 4 year period in the present value
terms, if he continues to buy water from the neighbour rather than go for the well which would have a
life of 4 years. Mr Anish has 3 decisions to make. (a) Should he drill upto 200 feet (b) if no water is
found at 200 feet, should he drill upto 250 feet? (c) should he continue to buy water from his
neighbour?

7.A large steel manufacturing company has 3 options with regard to production (i) produce
commercially (ii) build pilot plant(iii) stop producing steel. The management has estimated that their
pilot plant, if built, has 0.8 chance of high yield and 0.2 chance of low yield. If the pilot plant does
show a high yield, management assigns a probability of 0.75 that the commercial plant will also have
a high yield. If the pilot plant shows a low yield, there is only a 0.1 chance that the commercial plant
will show a high yield. Finally, management’s best assessment of the yield on a commercial size plant
without building a pilot plant first has a 0.6 chance of high yield. A pilot plant will cost Rs 3,00,000.
The profits earned under high and low yield conditions are Rs 1,20,00,000 and - Rs 12,00,000
respectively. Find the optimum decision for the company.

8.A businessman has two independent investment portfolios A and B, available to him, but he lacks
the capital to undertake both of them simultaneously. He can either choose A first and then stop, or if
A is not successful, then take, B or vice versa. The probability of success of A is 0.6, while for B it is
0.4. Both investment schemes require an initial capital outlay of Rs 10,000 and both return nothing if
the venture proves to be unsuccessful. Successful completion of A will return Rs 20,000 (over cost)
and successful completion of B will return 24,000 (over cost). Draw a decision tree in order to
determine the best strategy.

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9.The Indian Yacht company has developed a new cabin cruiser which they have earmarked for the
medium to large boat market. A market analysis has a 30% probability of annual sales being 5000
boats, a 40% probability of 4000 annual sales and a 30% probability of 3000 annual sales. This
company can go into limited production, where variable costs are rs 10,000 per boat, and fixed costs
are Rs 8,00,000 annually. Alternatively, they can go into full scale production, where variable costs
are Rs 9000 per boat, and fixed costs are Rs 50,000 annually. If the new boat is to be sold for Rs
11,000 should the company go into limited or full scale production when their objective is to
maximize the expected profits?

10.Developing a small driving range for golfers of all abilities has long been a desire of John. He however
believes that the chance of a successful driving range is only about 40%. A friend of John has suggested that
he conduct a survey in the community to get a better feeling of the demand for such a facility. There is a 0.9
probability that the research will be favourable if the driving range facility will be successful. Furthermore it
is estimated that there is a 0.8 probability that the marketing research will be unfavourable if indeed the
facility will be unsuccessful. John would like to determine the chances of a successful driving range given a
favourable result from the marketing survey.

11.In a bolt manufacturing factory, machines A, B and C manufacture 25%, 35% and 40% respectively, of the
total output. The defective bolts manufactured on machines A, B and c are 5%, 4% and 2% respectively. If a
bolt is drawn at random from the output and is found to be defective, what are the chances that the bolt was
manufactured on machine A, B or C?

12.A company receives shipments of certain items. It should decide whether to accept or reject the shipment
on the basis of a sample selected from the shipment. From the past experience, it is known that the percentage
of defective items in a batch of shipment is 0, 2 or 5, the probabilities of which are 0.5, 0.3 and 0.2
respectively. The company can accept only those batches that have no defectives. The cost of rejecting a good
batch, that is, a batch with no defective item is Rs 200. The cost of accepting a defective batch is Rs 600. A
sample of 10 items has been selected from the shipment and two items are found to be defective. The
conditional probabilities of getting two defectives in a sample pf 10 items from a batch of 0%, 2% and 5%
defectives are calculated as 0.083, 0.185 and 0.265, respectively. Determine whether the shipment should be
accepted?

13.A car manufacturer is considering manufacturing a low cost car along with its present range of cars. This
project would incur extra cost but would also result in extra profit in case the expected demand is high. In case
the demand is low, then there is a possibility of a loss. The data is given in table and the figures are in millions
of rupees.

Expected Demand Probability Manufacture Do not manufacture

High 0.25 +200 0
Low 0.75 -300 0

The company wishes to engage a marketing consultant to make a proper estimate of sales and this consultant
is going to charge Rs 0.2 million. The consultant finds a correlation between the demand and sales and
provides additional information as given in table below.
Expected Demand Probability of Sales forecast
High Medium Low
High 0.5 0.3 0.2
Low 0.1 0.5 0.4

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 (a) Determine the decision the company would take when the marketing consultant’s additional data is not
known.
(b) Determine the decision the company would take when the marketing consultant’s additional data is
known.
(c) Is the consultant’s fees justified? How much additional profit the company would generate by
engaging the consultant?

14. The Gorman manufacturing company must decide whether to manufacture a component part at its Milan,
Michigan plant or purchase the component part from the supplier. The resulting profit is dependent upon the
demand for the product. The following pay off table shows the projected profit (in $1000s)
Decision Low Demand Medium Demand High Demand
Manufacture -20 40 100
Purchase 10 45 70
The state of nature probabilities are P(s1)=0.35, P(s2)=0.35 and P(s3)=0.30
(a) Use a decision tree to recommend a decision
(b) Use EVPI to determine whether Gorman should attempt to obtain a better estimate of demand.
(c) A test market study of the potential demand for the product is expected to report wither a favorable (F)
or unfavorable(U) condition. The relevant conditional probabilities are:
P(F/s1)=0.10, P(U/s1)=0.90
P(F/s2)=0.40, P(U/s2)=0.60
P (F/s3)=0.60, P(U/s3)=0.40
What is the probability that the market research report will be favourable?
(d) What is the efficiency of the information?