Graduate Business Administration 509

MANAGERIAL DECISION MAKING
Fall 2003
 
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Answers to Recommended Problems

Chapter 14

12.  This will be answered in two ways:  

(1)  Suppose each stage can be undertaken independently, in any order.

CA = $5 M, PA = 0.2 => PA / CA = 0.2 / 5 = 0.04

CB = $3 M, PB = 0.3 => PB / CB = 0.3 / 3 = 0.10

CC = $4 M, PC = 0.2 => PC / CC = 0.1 / 4 = 0.025

The order in which the stages should be undertaken is B => A => C.

A stage should be undertaken if P > P* (= C / profit) or P* < P

Profit = $20

P*B =  3 / 20 = 0.15 < 0.3 => undertake stage B

P*A =  5 / 20 = 0.25 > 0.2 => don't undertake stage A

=> Try stage B, but if it's unsuccessful, don't go any farther

The expected profit is 20 * (0.3) - 3 = $3 M

(2)  Suppose each stage has to be done in sequence.

  = Decision   = Chance

 

Failure
---------- (-12)
0.9
  Yes to C
-||---------		 -10
    Success
---------- (+8)
0.1
  Failure
------------
0.7

-8

  
    No to C
---------- (-8)		  
  Yes to B
------------

-2

  
    Success
---------- (+12)
0.3		  
  Failure
------------
0.8

-2

  
    No to B
-||------- (-5)		  
  Yes to A
------------		 1.4  
    Success
---------- (+15)
0.2		  
1.4  
  No to A
-||------- (0)		  

The appropriate investment policy is to invest in stage A and invest in stage B if stage A fails, but not to go on to stage C if stage B fails.  The expected profit is 1.4.