Question

Part 1: Luna, a former class mate of Kiana’s, has developed a new product called the Cat Castle. Luna came to Kiana for advice on how she should evaluate her options. Kiana suggested they develop a payoff table and then use it to evaluate her options. First, they had to determine the Decision Alternatives, States of nature and payoffs.
Luna was trying to decide between:
(1)    Sell the product to another company and move to the beach,
(2)    Hire SBPR to market and distribute the product,
(3)    Market the product herself and sell on Amazon.
Selling the product directly, she can sell it for $45,000.
If she chooses to hire SBPR to market and distribute the product, her payoff will depend on the economic environment (or states of nature). If the economy is “good”, then the estimated payoff to Luna is $85,000. “Moderate” economy is estimated to have a payoff of 60,000. “Bad” economy is estimated to have a payoff of $35,000 and if there is “Financial Crisis”, Luna would lose $500.
If she chooses to market the product herself and sell on Amazon, her payoffs are as follows: If there is “good” economy, she estimates a payoff to be $100,000. “Moderate” economy is estimated to have a payoff of $70,000. “Bad” economy is estimated to have a payoff of $40,000 and “Financial Crisis “would cost Luna $15,000.
Questions: fill in the answers to the following questions
1)      What are the decision alternatives? What are the States of Nature? What are the payoffs?
Build the payoff table on Excel and label these items.
2)      What’s the best decision based on Maximin?
3)      What’s the best decision based on Maximax?
4)      Laplace?
5)      Minimax Regret?
Part II: Jason, an economist friend has done research on the future economic environment and has determined that there is 30% chance of good economy, a 45% chance of moderate economy, a 20% chance of bad economy, and 5% chance of financial crisis.
Questions:
1)      What is the expected payoff if Luna choose to hire SBPR to market and distribute the product?
2)      Calculate the EVUPI.
3)      What is the EVPI?
4)      What is the best decision for Luna based on Expected Opportunity Loss(EOL)?

Answer 1

1)

The decision alternatives, states of nature and payoffs are shown in the payoff table as shown below:

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2) Maximin

Maximum of the minimum payoffs of all the alternatives is 45000 pertaining to decision alternative Sell to another company

Therefore, the best decision is: Sell to another company

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3) Maximax

Maximum of the Maximum payoffs of all alternatives is 100,000 pertaining to decision alternative Market the product herself, and sell on amazon

Therefore, the best decision is: Market the product herself, and sell on amazon

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4) Laplace

Maximum of the Average payoffs of all alternatives is 48,750 pertaining to decision alternative Market the product herself, and sell on amazon

Therefore, the best decision is: Market the product herself, and sell on amazon