Solve the given question: Kenneth Brown is the principal owner of Brown Oil, Inc

ID: 3042823 • Letter: S

Question

Solve the given question:

Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives as the following:

1- Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000.

2- Ken purchases a Oiler J and if there is a favorable market, he will realize a profit of $250,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $100,000.

3- Ken purchases a Texan and if there is a favorable market, he will realize a profit of $75,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $18,000.

Answer the fallowing:

1- Develop a decision table showing the alternatives, states of nature, and related consequences.

2- If Ken has always been a very optimistic decision maker

A- What type of decision is Ken facing?

B- What decision criterion should he use?

C- What alternative is best?

3- Develop a decision tree.

4- If Ken knows the probabilities that associated with each possible states of nature as 0.5 for each state.

A- What type of decision is Ken facing?

B- What decision criterion should he use?

C- What alternative is best?

Explanation / Answer

Part (1)

All given data are tabulated precisely below for easy comprehension.

Pay-off ($’000)Table

Decision (Purchase Option)

State of Nature (SON) Market Condition

Row Max

EMV

Favourable

Unfavourable

A Sub 100

300

- 200

300

A Oiler J

250

- 100

250

A Texan

- 18

28.5

Probability

0.5

Part (2)

Very optimistic decision would be Maximaxi Criterion where in the decision maker evaluates the maximum pay-off for each decision option and opts for the maximum of these maximums. This, in practical terms is: maximum of row maximum.

Since 300 is the maximum of row maximums, decision is to purchase A Sub 100 ANSWER

Part (3 & 4)

Here the decision criterion is EMV (Expected Monetary Value), wherein the decision maker evaluates Expected Monetary Value for each decision option and opts for that decision for which EMV is maximum.

Expected Monetary Value for a decision

= sum of (pay-off under SON x probability of SON) summed over all possible SON.

EMV’s are given in the above table.

Since 75 is the maximum EMV, best decision is to purchase A Oiler J ANSWER