Question

Book :Business Analytics 6^th edition (data analysis and decision making)

By s. Chirstian albright and wayne. L . w

A

If your company makes a particular decision in the face of uncertainty, you estimate that it will either gain $10,000, gain $1000, or lose $5000, with probabilities 0.40, 0.30, and 0.30, respectively. You (correctly) calculate the EMV as $2800. However, you distrust the use of this EMV for decision-making purposes. After all, you reason that you will never receive $2800; you will receive $10,000, $1000, or lose $5000. Discuss this reasoning.

B

In the previous question, suppose you have the option of receiving a check for $2700 instead of making the risky decision described. Would you make the risky decision, where you could lose $5000, or would you take the sure $2700? What would influence your decision?

C

A potentially huge hurricane is forming in the Caribbean, and there is some chance that it might make a direct hit on Hilton Head Island, South Carolina, where you are in charge of emergency preparedness. You have made plans for evacuating everyone from the island, but such an evacuation is obviously costly and upsetting for all involved, so the decision to evacuate shouldn’t be made lightly. Discuss how you would make such a decision. Is EMV a relevant concept in this situation? How would you evaluate the consequences of uncertain outcomes

Answer 1

A

Yes, the reasoning is correct. EMV is not the actual value, but the expected value by considering the possible outcomes and their probabilities. But EMV is useful when one is uncertain between 2 or more options. However, it depends on whether a person is risk averse or risk seeker or risk moderate. EMV is only useful during uncertain situations.

B

I would take the sure $2700 because I am not a risk seeker. Because, EMV is $2800, which is only $100 more than $2700 but this is certain amount where as EMV is not the actual amount and there is uncertainty and risk of losing $5000, gaining $1000 which is again less than $2700 and only one higher outcome of $10,000 with 0.40 probability(less than 50%). But the risk seekers always prefer to make risky decision as there eyes will be on $10,000 and 0.40 is a good probability for them to bet on it. They don't care to lose $5000 and so, are called risk seekers and also $10,000 is far away from $2700.

C

I would take the decision to evacuate everyone even though there is only small chance of hitting by hurricane without bothering about the costs involved as it involves the lives of people and EMV is not a relevant concept in this situation. Study of past events of such hurricanes is useful.