Homework 7: Decision-Making under Risk,
Due Thursday 10/22 at 12pm (noon)
CSCI 510, Fall 2015
30 points
The MedFRS project has selected Company L to develop, produce, and field test the
First Responder Workstations (FRWs), and train the first-responder personnel in
their use.
Company L has identified two candidate approaches for developing and producing
the FRWs. The Bold approach B will give them a profit of $600K if it succeeds, but a
loss of $100K if it fails. The Conservative Approach C will give them a profit of
$200K for sure.
1. (12 points). Initial analysis
a. Construct the payoff matrix for the decision situation.
b. Determine the best decisions and payoffs under:
i. the Maximin rule;
ii. the Maximax rule; and
iii. the Laplace rule.
c. Determine the breakpoint probability of Bold approach success above
which the Bold approach will be preferable.
2. (12 points). Value of perfect information
a. Determine the Expected Value of Perfect Information (EV)perfect info:
the payoff if Company L had perfect information about the success or
failure of the Bold approach. Assume that the original success or
failure probabilities were equally likely at 0.5 each.
b. Determine the Expected Value of No Information (EV)no info: the
payoff if Company L had no information about the success or failure of
the Bold approach. Assume that the original success or failure
probabilities were equally likely at 0.5 each.
c. Determine the Expected Value of Acquiring Perfect Information
(EVPI): the maximum investment in acquiring information on the
success of the Bold approach that would be worth doing.
3. (6 points). RRL for prototypes
Company L also identifies two levels of prototyping that would buy information
to reduce the risk of proceeding with no information. Prototype X would cost
$20K and reduce the risk of B failing from $100K to $50K. Prototype Y would
cost $40K and reduce the risk from $100K to $20K.
a. Compute the Risk Reduction Leverage (RRL) for Prototypes X and Y.
b. Identify which is the better investment.