Problem 3: The Miramar Company is going to introduce one of three new products: a widget, a

hammer, or a nimnot. The market conditions (favorable, stable, or unfavorable) will determine the profit
or loss the company realizes, as shown in the following payoff table.

MARKET CONDITIONS
PRODUCT Favorable Stable Unfavorable
.2 .7 .1
Widget $120,000 $70,000 $-30,000
Hammer $60,000 $40,000 $20,000
Nimnot $35,000 $30,000 $30,000

a. Compute the expected value for each decision and select the best one.

EMV (d1) Widget: .2(120000) + .7(70000) + .1(-30000) = $70,000

EMV (d2) Hammer: .2(60000) + .7(40000) + .1(20000) = $42,000
EMV (d3) Nimnot: .2(35000) + .7(30000) + .1(30000) = $31,000
The best decision would be to introduce the Widget (d1).

b. Develop the opportunity loss table and compute the expected opportunity loss for each
product.

Regret Table
PRODUCT Favorable Stable Unfavorable
.2 .7 .1
Widget $0 $0 $6,000
Hammer $60,000 $30,000 $10,000
Nimnot $85,000 $40,000 $0

EOL (d1) Widget: .2(0) + .7(0) + .1(60000) = $6,000

EOL (d2) Hammer: .2(60000) + .7(30000) + .1(10000) = $34,000
EOL (d3) Nimnot: .2(85000) + .7(40000) + .1(0) = $45,000
The best decision would be to introduce the Widget (d1).

c. Determine how much the firm would be willing to pay to a market research firm to gain better
information about future market conditions.

EVUC: .2(120000) + .7(70000) + .1(30000) = $76,000

EMV: (d1) Widget: $70,000
EVPI: EVUC – EMV = 76000 – 70000 = $6,000
The firm would be willing to pay a market research firm up to $6,000 to gain better
information about future market conditions.
Problem 4: The Loebuck Grocery must decide how many cases of milk to stock each week in order to
meet demand. The probability distribution of demand during a week is shown in the following table.
Each case costs the grocer $10 and sells for $12. Unsold cases are sold to a local farmer (who mixes the
milk with feed for livestock) for $2 per case. If there is a shortage, the grocer considers the cost of
customer ill will and lost profit to be $4 per case. The grocer must decide how many cases of milk to
order each week.

  Demand
Stock 15 16 17 18
Milk Cases 0.20 0.25 0.40 0.15
15 $30 $26 $22 $18
16 $22 $32 $28 $24
17 $14 $24 $34 $30
18 $6 $16 $26 $36

b. Compute the expected value of each alternative amount of milk that could be stocked, and
select the best decision.

EMV (d1) 15: .2(30) +.25(26) + .4(22) + .15(18) = $24.00

EMV (d2) 16: .2(22) +.25(32) + .4(28) + .15(24) = $27.20
EMV (d3) 17: .2(14) +.25(24) + .4(34) + .15(30) = $26.90
EMV (d4) 18: .2(6) +.25(16) + .4(26) + .15(36) = $21.00
The best decision would be for Loebuck Grocery to stock 16 milk cases each week.

c. Construct the opportunity loss table and determine the best decision.

Regret Table
Stock 15 16 17 18
15 $0 $6 $12 $18
16 $8 $0 $6 $12
17 $16 $8 $0 $6
18 $24 $16 $8 $0

EOL (d1) 15: .2(0) +.25(6) + .4(12) + .15(18) = $9.00

EOL (d2) 16: .2(8) +.25(0) + .4(6) + .15(12) = $5.80
EOL (d3) 17: .2(16) +.25(8) + .4(0) + .15(6) = $6.10
EOL (d4) 18: .2(24) +.25(16) + .4(8) + .15(0) = $12.00
The best decision would be for Loebuck Grocery to stock 16 milk cases each week.

d. Compute the expected value of perfect information.

EVUC: .2(30) + .25(32) + .4(34) + .15(36) = $33.00
EMV: (d2) 16: $27.20
EVPI: EVUC – EMV = 33 – 27.2 = $5.80
The expected value of perfect information (EVPI) is $5.80.