Question

Cal Bender and Becky Addison have known each other since high school. Two years ago they

entered the same university and today they are taking undergraduate courses in the business school. Both hope to

graduate with degrees in finance. In an attempt to make extra money and to use some of the knowledge gained from

their business courses, Cal and Becky have decided to look into the possibility of starting a small company that would

provide word processing services to students who needed term papers or other reports prepared in a professional

manner.

Using a system approach, Cal and Becky have identified three strategies. Strategy 1 is to invest in a fairly expensive

microcomputer system with a high-quality laser printer. In a favorable market, they should be able to obtain a net profit

of $10,000 over the next 2 years. If the market is unfavorable, they can lose $8,000. Strategy 2 is to purchase a less

expensive system. With a favorable market, they could get a return during the next 2 years of $8,000. With an

unfavorable market, they would incur a loss of $4,000. Their final strategy, strategy 3, is to do nothing. Cal is basically

a risk taker, whereas Becky tries to avoid risk.

1- What type of decision procedure should Cal use? What would Cal’s decision be?

2- What type of decision maker is Becky? What decision would Becky make?

3- If Cal and Becky were indifferent to risk, what type of decision approach should they use? What would you

recommend if this were the case?

Answer 1

Solution: Let us use a decision table to answer the above question.

Strategies	Favorable market($)	Unfavorable market($)
1	10000	-8000
2	8000	-4000
3	0	0

The problem is based on one of the decision making under uncertainty.

a) We know, Cal is a risk taker and he should use the maximax decision criteria.In this approach, he selects the row that has maximum value. $10,000 is the maximum value from the above table.Therefore, he selects strategy 1, which is the optimistic decision approach.

b) Becky should use maximin decision criteria because he tries to avoid risk. The minimum outcome from the above table is -$8,000 for strategy 1,-$4,000 for strategy 2 and $0 for strategy 3. The maximum of these values is selected. Thus, Becky selects strategy 3 which is pessimistic decision approach.

c) If both had same risk taking approach, then they would use equally likely approach. This approach selects the alternative that maximizes the row averages.

Let us calculate the row average.

Strategy 1: (10,000-8,000)/2=$1,000

Strategy 2: (8,000-4,000)/2=$2,000

Strategy 2:$0

By using the equally likely approach, strategy 2 is the best decision which maximizes the row average.