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582 CHAPTER 13 DECISION ANALYSIS

12 Kotze Publishing Company received a six-chapter manuscript for a new college textbook. The
editor of the college division is familiar with the manuscript and estimated a 0.65 probability
that the textbook will be successful. If successful, a profit of E750 000 will be realized. If the
company decides to publish the textbook and it is unsuccessful, a loss of E250 000 will occur.
Before making the decision to accept or reject the manuscript, the editor is considering
sending the manuscript out for review. A review process provides either a favourable (F)or
unfavourable (U) evaluation of the manuscript. Past experience with the review process suggests
probabilities P(F) ¼ 0.7 and P(U) ¼ 0.3 apply. Let s 1 ¼ the textbook is successful, and s 2 ¼ the
textbook is unsuccessful. The editor’s initial probabilities of s 1 and s 2 will be revised based on
whether the review is favourable or unfavourable. The revised probabilities are as follows.
Pðs 1 jFÞ¼ 0:75 Pðs 1 jUÞ¼ 0:417
Pðs 2 jFÞ¼ 0:25 Pðs 2 jUÞ¼ 0:583
a. Construct a decision tree assuming that the company will first make the decision of
whether to send the manuscript out for review and then make the decision to accept or
reject the manuscript.
b. Analyze the decision tree to determine the optimal decision strategy for the publishing
company.
c. If the manuscript review costs E5000, what is your recommendation?
d. What is the expected value of perfect information? What does this EVPI suggest for the
company?
13 Romero’s Department Store faces a buying decision for a seasonal product for which
demand can be high, medium or low. The purchaser for Romero’s can order 1, 2 or 3 lots
of the product before the season begins but cannot reorder later. Profit projections (in
thousands of euros) are shown.

State of Nature
High Demand Medium Demand Low Demand
Decision Alternative s 1 s 2 s 3
60 60 50
Order 1 lot, d 1
80 80 30
Order 2 lots, d 2
100 70 10
Order 3 lots, d 3
a. If the prior probabilities for the three states of nature are 0.3, 0.3 and 0.4, respectively,
what is the recommended order quantity?
b. At each preseason sales meeting, the vice president of sales provides a personal opinion
regarding potential demand for this product. Because of the vice president’s enthusiasm
and optimistic nature, the predictions of market conditions have always been either
‘excellent’(E) or ‘very good’ (V). Probabilities are as follows.
PðEÞ¼ 0:70 Pðs 1 j EÞ¼ 0:34 Pðs 1 j VÞ¼ 0:20
PðVÞ¼ 0:30 Pðs 2 j EÞ¼ 0:32 Pðs 2 j VÞ¼ 0:26
Pðs 3 j EÞ¼ 0:34 Pðs 3 j VÞ¼ 0:54
What is the optimal decision strategy?
c. Use the efficiency of sample information and discuss whether the firm should consider a
consulting expert who could provide independent forecasts of market conditions for the
product.
14 Suppose that you are given a decision situation with three possible states of nature: s 1 , s 2
and s 3 . The prior probabilities are P(s 1 ) ¼ 0.2, P(s 2 ) ¼ 0.5 and P(s 3 ) ¼ 0.3. With sample
information I, P(I|s 1 ) ¼ 0.1, P(I|s 2 ) ¼ 0.05 and P(I|s 3 ) ¼ 0.2. Calculate the revised or
posterior probabilities: P(s 1 |I), P(s 2 |I), and P(s 3 |I).

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