Chapter 5

# Chapter 5 - Chapter 5 Making Hard Decisions R T Clemen T...

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Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 1 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1 Sensitivity Analysis Chapter 5 Making Hard Decisions R. T. Clemen, T. Reilly

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Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 2 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1 Introduction Sensitivity analysis is used through the entire modeling process Purpose of sensitivity analysis: • To analyze what really matters in the decision problem • To construct a requisite decision model Examples of sensitivity analysis techniques in DA: Determine if deterministic dominance or stochastic dominance is present Identifying the important variables through tornado diagrams Identify interaction effects between important variables Identify the importance of probability assessments (which are also variables).
Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 3 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1 The Eagle Airline Case Dick Carothers wants to expand his operation. Mid West has to offer: An airplane @ price \$95000. (He can probably by the plane for \$85K-\$90K) An option to buy the airplane a year later (Cost of the option \$2.5 – \$4k) Currently: Eagle Airlines (=Dick Carothers) owns 3 plains 60% of flights are chartered flights and 40% are scheduled

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Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 4 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1 The Eagle Airline Case Cost Data Mid West Plane: New Engines, FAA Maintained Contains all equipment that Eagle Airlines needs Has 5 seats Operation Cost: \$245 per hour Fixed Cost: \$20k (=Yearly Insurance) + Finance Charges Finance Charges: Borrow 40% of the price at 2% above the prime rate (=9.5%, but subject to change). Revenue Data: Chartered Flights: \$300 - \$400 per hour Scheduled Flights: \$100 per person per hours, plains are on average 50% full Expected number of hours flown with new plane 800-1000.
Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 5 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1 The Eagle Airline Case Variables in control: • The price he is willing to pay. • The amount financed. Variables not in control: • Insurance Cost • Operation Cost Carothers could always invest his cash \$52,500 @8% yearly interest rate , yielding an annual interest in the first year of: \$4200 What should Dick Carothers do?

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Making Hard Decisions R. T. Clemen, T. Reilly Chapter 5 – Sensitivity Analysis Lecture Notes by: J.R. van Dorp and T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/ Slide 6 of 29 COPYRIGHT © 2006 by GWU Draft: Version 1
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• Spring '10
• ShamimAbdullah
• Sensitivity analysis, Best, worst and average case, J.R. van Dorp, T.A. Mazzuchi http://www.seas.gwu.edu/~dorpjr/

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