Decision Analysis

Decision Analysis - DS 412 Operations Management Decision...

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DS 412 Operations Management Decision Analysis Supplement Ch 5

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Decision Analysis It is common that business decisions have to be made before one knows how an important but uncertain event takes place in the future. The profit or loss will be based on how the uncertainty materializes in the future. Example: A chip manufacturer must invest a huge amount of money developing a new chip design before they know the market demand? Example: Individuals must decide between two alternative health benefit plans before they know their health coverage needs for certain. …. Examples of decision making facing uncertainty are everywhere in
Decision Analysis Decision analysis (DA) is a structured approach that helps in evaluating alternatives and making decisions. DA is suitable for a wide range of operations management decisions . Two main factors that affect the quality of decisions: 1. Availability of information, accuracy, timeliness 2. Mechanics of the decision making process

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The Decision Making Process 1. Identify possible future conditions called states of nature (events) 2. Develop a list of possible alternatives (decisions) , one of which may be to do nothing 3. Determine the payoff (profit or loss) associated with each alternative for every future condition 4. Evaluate alternatives according to some decision criterion and select the best alternative
Example: Capacity Expansion A manufacturer of storage devices is getting ready to produce a new product, but they are not sure what the demand will be. They categorize demand to be at three levels: low (10,000 units) , medium (40,000 units) or high (100,000 units) Alternative Actions: 1 . Outsource: generate \$60 profit per unit 2. Expand capacity: incur \$500,000K , but generate \$75 profit

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Profit calculations Outsource decision: If demand is low, profit = 60*(10,000) = \$600,000 If demand is medium, profit = 60*(40,000) = \$2,400,000 If demand is high, profit = 60*(100,000) = \$6000,000 Expand decision If demand is low, profit = 75*(10,000) - 500,000 = \$250,000 If demand is medium, profit = 75*(40,000) – 500,000 = \$2,500,000 If demand is high, profit = 750*(100,000) – 500,00 = \$7,000,000 To simplify computations, we will express all the above profits in (000’s), so \$600,000 will be expressed as \$600 in (000’s) of dollars and
The Payoff Table for the storage devices example Which decision is better? Outsource or expand? Do we need criteria to evaluate decisions? Do we need more information? Low Medium High 10,000 40,000 100,000 Outsource 600 2400 6000 Expand 250 2500 7000 Demand Profits in \$1000's

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Decision Making Environment : Certainty - Environment in which relevant parameters have known values Uncertainty - Environment in which it is impossible to assess the likelihood of various future events Risk - Environment in which certain future events have probable outcomes
Continued Low Medium High 10,000 40,000 100,000 Outsource 600 2400

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This note was uploaded on 11/10/2011 for the course DS 412 taught by Professor Eng during the Fall '07 term at S.F. State.

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Decision Analysis - DS 412 Operations Management Decision...

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