Topic 3_Decision Analysis (Part 3)(S) - FB2201 Management Sciences II Topic 3 Decision Analysis(Part 3(Solutions Q3.19 Shir Khan is considering

Topic 3_Decision Analysis (Part 3)(S) - FB2201 Management...

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FB2201 Management Sciences II Topic 3: Decision Analysis (Part 3) (Solutions) Q3.19 Shir Khan is considering investing some money that he inherited. The following payoff table gives the profits that would be realized during the next year for each of three investment alternatives Shir is considering: State of Nature Decision Alternative Good Economy Poor Economy Stock market 80,000 -20,000 Bond 30,000 20,000 CDs 23,000 23,000 Probability 0.5 0.5 (a). What decision would maximize expected profits? Solution State of Nature Decision Alternative Good Economy, (0.5) Poor Economy, (0.5) EMV Stock market 80,000 -20,000 30,000 Bond 30,000 20,000 25,000 CDs 23,000 23,000 23,000 EMV (Stock market) = 80,000×0.5 + (-20,000) ×0.5 = 30,000 EMV (Bond) = 30,000×0.5 + 20,000×0.5 = 25,000 EMV (CDs) = 23,000×0.5 + 23,000×0.5 = 23,000 The best decision is to invest in stock market with EMV = $30,000. (b). What is the maximum amount that should be paid for a perfect forecast of the economy? Solution EVPI = EV (with prefect information) - (Maximum EV without prefect information) = (0.5×80,000) + (0.5×23,000) - 30,000 = 51,500 - 30,000 = $21,500 1
Q3.22 In Problem 3-21, you helped Ziang Zameen determine the best investment strategy. Now, Zameen is thinking about paying for a stock market newsletter. A friend of Zameen said that these types of letter s could predict very accurately whether the market would be good, fair, or poor. Then, based on these predictions, Ziang could make better investment decisions. (a). What is the most that Ziang would be willing to pay for a newsletter? Solution EV with Perfect Information=1,400×0.4 + 900×0.4 + 900×0.2 = $1,100 EMV (CD) without information = $900 Therefore, the most Ziang would be willing to pay for a newsletter =1,100 – 900 = $200. (b). Ziang now believes that a good market will give a return of only 11% instead of 14%. Will this information change the amount that Ziang would be willing to pay for a newsletter? If your answer is yes, determine the most that Ziang would be willing to pay, given this new information.

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