Question

Marcia owns a coffee shop on Main Street. She is contemplating the future of her current coffee shop. She is considering six alternative decisions: (1) sell her business and leave the coffee industry, (2) sell her current shop and open a coffee cart on College Hill, (3) maintain her current business (i.e., status quo), (4) expand hours at her current shop, (5) expand hours and retail area at her current location, and (6) relocate to a larger retail space on University Avenue Marcia's expected profit will depend on the future demand for her coffee. Her expected payoffs are as follows: Future demand for Marcia's Coffee Very High High Moderate Low Very Low Si S4 S5 2000 -1000 S3 0 1000 S2 -750 500 700 1500 D2 -500 1250 1500 800 500 250 0 Sell shop & leave industry Sell shop & open cart Status quo Expand hours Expand hours and retail area Relocate to University Avenue 1500 1400 1000 0 -500 1750 1500 1000 0 -750 DO 2500 1750 1250 -1000 -2000 Use Excel to answer the following: a. Identify Marcia's optimal decision alternative under each of the four approaches of decision making without probability. b. Suppose Marcia has the following probabilities regarding economic growth: P(S1) = 0.20, P(S2) = 0.25, P(S3) = 0.10, and P(S4) = 0.20. What is her optimal decision alternative using the Expected Value approach? c. What is Marcia's EVPI? d. If instead, Marcia believes P(Si)=0.30, P(S2) = 0.20, P(S3) = 0.15, and P(S4) = 0.25, what is her optimal decision alternative using the Expected Value approach and the corresponding EVPI?

Answer 1

a)

		very high	high	moderate	low	very low	Minimum payoff	Maximum payoff	Sum of all uncertainities	Minimax regret criterion
		S1	S2	S3	S4	S5
Sell shop and leave industry	D1	-1000	-750	0	1500	2000	-1000	2000	1750	2500
Sell shop and open cart	D2	-500	500	1000	1250	1500	-500	1500	3750	1750
Status quo	D3	800	700	500	250	0	0	800	2250	1750
Expand hours	D4	1500	1400	1000	0	-500	-500	1500	3400	1500
Expand hours and retail area	D5	1750	1500	1000	0	-750	-750	1750	3500	1750
Relocate to university Avenue	D6	2500	1750	1250	-1000	-2000	-2000	2500	2500	2500
Marcia's optimun Decision alternative
Maxmin Decision	Status quo
Maximax criterion	Status quo
Principle of insufficient Reason	Expand hours and Retail area
Minimax Regret criterion	Relocate to university Avenue

b)

		very high	high	moderate	low	very low	Expected value
		S1	S2	S3	S4	S5
Sell shop and leave industry	D1	-1000	-750	0	1500	2000	412.5
Sell shop and open cart	D2	-500	500	1000	1250	1500	750
Status quo	D3	800	700	500	250	0	435
Expand hours	D4	1500	1400	1000	0	-500	625
Expand hours and retail area	D5	1750	1500	1000	0	-750	637.5
Relocate to university Avenue	D6	2500	1750	1250	-1000	-2000	362.5
PROBABILITY		0.2	0.25	0.1	0.2	0.25
Optimum decision using expected value approach	Sell shop and open Cart

.

3.		very high	high	moderate	low	very low	Expected value
		S1	S2	S3	S4	S5
Sell shop aand leave industry	D1	-1000	-750	0	1500	2000	412.5
Sell shop and open cart	D2	-500	500	1000	1250	1500	750
Status quo	D3	800	700	500	250	0	435
Expand hours	D4	1500	1400	1000	0	-500	625
Expand hours and retail area	D5	1750	1500	1000	0	-750	637.5
Relocate to university Avenue	D6	2500	1750	1250	-1000	-2000	362.5
PROBABILITY		0.2	0.25	0.1	0.2	0.25
Max figure		2500	1750	1250	1500	2000
	Calculation of EVPI( expected Value of perfect information)
Firstly, calculate ERPI(Expected return with perfect information) i.e (max value)x(probability)							1862.5
	EVPI =ERPI-EREV (calculated in b)
	EVPI =	1112.5

4.

		very high	high	moderate	low	very low	Expected value
		S1	S2	S3	S4	S5
Sell shop and leave industry	D1	-1000	-750	0	1500	2000	-75
Sell shop and open cart	D2	-500	500	1000	1250	1500	412.5
Status quo	D3	800	700	500	250	0	517.5
Expand hours	D4	1500	1400	1000	0	-500	880
Expand hours and retail area	D5	1750	1500	1000	0	-750	975
Relocate to university Avenue	D6	2500	1750	1250	-1000	-2000	1037.5
PROBABILITY		0.3	0.2	0.15	0.25	0
Max figure		2500	1750	1250	1500	2000
	Calculation of EVPI( expected Value of perfect information)
Firstly, calculate ERPI(Expected return with perfect information) i.e (max value)x(probability)							1662.5
	EVPI =ERPI-EREV (calculated in b)
	EVPI =	625