Practice Questions on Decision Analysis - Exam III - Practice Questions on Decision Analysis 1(Q 34 in textbook A group of medical professionals is

# Practice Questions on Decision Analysis - Exam III -...

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Practice Questions on Decision Analysis
1. (Q 34 in textbook) A group of medical professionals is considering the construction of a private clinic. If the medical demand is high (i.e., there is a favorable market for the clinic), the physicians could realize a net profit of \$100,000. If the market is not favorable, they could lose \$40,000. Of course, they don’thave to proceed at all, in which case there is no cost. In the absence of any market data, the best physicians can guess is that there is a 50-50 chance that the clinic will be successful. Construct a decision tree to help analyze this decision problem. What should the physicians do?
Solution A Construct Clinic B Favorable Market Unfavorable Market Do not construct
A Construct Clinic B Favorable Market Unfavorable Market Do not construct \$0 \$100,000 -\$40,000 0.5 0.5
A Construct Clinic B Favorable Market Unfavorable Market Do not construct \$0 \$100,000 -\$40,000 0.5 0.5 Expected Monetary Value of Node B: 0.5 X \$100,000 + 0.5 X (-\$40,000) = \$30,000 \$30,000 At Node A: there are two alternatives Construct Clinic \$30,000 Do not construct \$0 Thus, choose “Construct Clinic”, Expected Monetary Value of Node A becomes \$30,000. \$30,000
2) The physicians have been approached by a market research firm that offers to perform a market study at a fee of \$5000. The market researchers claim that their experience enables them to make the following estimations: P (a favorable market | a favorable market-study result) = 0.82 P (an unfavorable market | a favorable market market-study result) = 0.18 P (an unfavorable market | an unfavorable market-study result) = 0.89 P (a favorable market | an unfavorable market-study result) = 0.11 P (a favorable market-study result) = 0.55 P (an unfavorable market-study result) = 0.45 a) Construct a decision tree to help analyze this decision problem. b) What should the physicians do? c) What is the maximum amount of money that physicians should be willing to pay for a market-study
Solution A Construct Clinic B Favorable Market Unfavorable Market Do not construct Conduct Market Study C Favorable Result Unfavorable Result D Do not construct Construct Clinic F E Favorable Market Unfavorable Market Do not construct G Favorable Market Unfavorable Market Construct Clinic
A Construct Clinic B Favorable Market Unfavorable Market Do not construct Conduct Market Study C Favorable Result Unfavorable Result D Do not construct Construct Clinic F E Favorable Market Unfavorable Market Do not construct G Favorable Market Unfavorable Market \$0 -\$5,000 -\$5,000 \$100,000 -\$40,000 \$95,000 -\$45,000 \$95,000 -\$45,000 0.5 0.5 0.82 0.18 0.89 0.11 0.55 0.45 Construct Clinic
Solving the Decision Tree Expected Monetary Value of Node E 0.82 X \$95,000 + 0.18 X (-\$45,000) = \$69,800 Expected Monetary Value of Node G 0.11 X \$95,000 + 0.89 X (-\$45,000) = -\$29,600
A