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Purpose
To assess your ability to:
- make decisions under uncertainty and risk using decision trees
- apply the utility theory to make a decision
Action Items
- Complete the following case making certain that you address all the questions in the case.
- Case Study: Waldo Books. If you have any difficulty completing the case, you should work through the problems at the end of Chapter 3 in Quantitative Analysis for practice.
- Place the problem in an Excel worksheet.
Submission Instructions
- Complete and submit this assignment per your professor’s instructions.
Grading Criteria
- Documentation: thorough documentation with clarity of thought and process: 0 – 2 points
- Problem solving and analysis:
- Solution is accurate (0 – 1 point)
- Calculations are accurate and valid (0 – 1 point)
- Responses are detailed and accurate (0 – 1 point)
Purpose
To assess your ability to use decision trees and probability to identify various possible solutions.
Action Items
- Review Problems 3-22 and 3-23 in Quantitative Analysis.
Problem 3-22
Allen Young has always been proud of his personal investment strategies and has done very well over the past several years. He invests primarily in the stock market. Over the past several months, however, Allen has become very concerned about the stock market as a good investment. In some cases it would have been better for Allen to have his money in a bank than in the market. During the next year, Allen must decide whether to invest $10,000 in the stock market or in a certificate of deposit (CD) at an interest rate of 9%. If the market is good, Allen believes that he could get a 14% return on his money. With a fair market, he expects to get an 8% return. If the market is bad, he will most likely get no return at all—in other words, the return would be 0%. Allen estimates that the probability of a good market is 0.4, the probability of a fair market is 0.4, and the probability of a bad market is 0.2, and he wishes to maximize his long-run average return.
(a) Develop a decision table for this problem.
(b) What is the best decision?
Problem 3-23
In Problem 3-22 you helped Allen Young determine the best investment strategy. Now, Young is thinking about paying for a stock market newsletter. A friend of Young said that these types of letters could predict very accurately whether the market would be good, fair, or poor. Then, based on these predictions, Allen could make better investment decisions.
(a) What is the most that Allen would be willing to pay for a newsletter?
(b) Young now believes that a good market will give a return of only II % instead of 14%. Will this information change the amount that Allen would be willing to pay for the newsletter? If your answer is yes, determine the most that Allen would be willing to pay, given this new information
- Create a model to support these problems using the OM plug-in for Excel (Decision Table Module).
- Place the problem in an Excel worksheet in separate worksheet tabs.
- Respond to each of the questions.
Submission Instructions
- Complete and submit this assignment per your professor’s instructions.
Grading Criteria
- Documentation: thorough documentation with clarity of thought and process: 0 – 2 points
- Problem solving and analysis: 0 – 4 points
Solution is accurate (0 – 2 points)
Calculations are accurate and valid (0 – 1 point)
Responses are detailed and accurate (0 – 1 point)