Success or failure of any undertaking mainly lies with the decisions made in every step of the undertaking. When it comes to business the main goal would be to maximize shareholders stake and attain maximum profitability. Therefore, it’s judicious to employ the best practices in decision making to arrive at the most practicable solution to a problem. (P.C & Jhunjhnuwala, 2010) Decision theory comes in as a discipline with a set of methods that assist decision makers to arrive at the best cause of action every problem has a these five main elements: decision maker, goals, situation, alternative cause of action and uneven results from choices.
Part 1
On the case of Thomson Lumber Company, the company is faced with three alternative cause of action one to construct a large plant second construct a small plant or do nothing. All these three alternatives are exposed to two states of nature a favorable market and unfavorable market condition each of this with equal probabilities of occurrence. Calculating the Expected monetary value (EMV) under the two market conditions for each of the three alternatives; calculating a large plant has an EMV of ten thousand dollars, constructing a small plant has a an expected monetary value of forty thousand dollars while doing nothing has an Expected monetary value of zero. The decision criteria under Expected monetary value will be to choose the alternative with the highest expected monetary value and in this case the best decision for Thomson Lumber Company will be to construct a small plant because being faced with the two states of nature it yields the highest EMV.
Under Expected value of perfect information (EVPI) Thomson Lumber Company will be looking at the maximum sum expended on obtaining perfect information. With conditions as stated above and upon adding an alternative namely with perfect information under favorable market condition the payoff is two hundred thousand dollars and zero payoff under unfavorable market condition with equal probabilities. Expected value of perfect information will be given by Expected monetary value with perfect information which is one hundred thousand dollars less the maximum EMV without perfect information calculated earlier to be forty thousand dollars thus expected value of perfect information is sixty thousand dollars.
The next decision technique under discussion is the expected opportunity loss also known as the expected regret. The approach of this technique is to focus on opportunity loss and the best cause of action will be the one with the least expected opportunity loss. The steps under this technique are; first prepare a payoff table with all alternative course of action, followed by a regret table gotten by subtracting all payoff values of an occurrence from the highest value of the payoff of that particular occurrence (P.C & Jhunjhnuwala, 2010). Considering Thomson Lumber company case drawing an opportunity loss table a decision to construct a large plant would cost the company an opportunity loss of ninety thousand dollars, a decision to construct a small plant would cost the company an opportunity loss of sixty thousand dollars while deciding to do nothing would cost the company one hundred thousand dollars. Under this technique a decision to construct a small plant would be the best alternative among all other alternatives. It should be noted that the minimum expected opportunity loss will always be equal to expected value of perfect information
Part 2
Taking a case scenario given of Dorothy Smith who is faced with three with three alternative to take Tennessee Street, back roads or Expressway under three states of nature; no traffic congestion, mild traffic congestion and severe traffic condition the three states of nature with probabilities of 0.5, 0.33 and 0.167 respectively. Dorothy is faced with a decision on which route to take, using the EMV technique to calculate the expected travel; taking Tennessee street takes an expect travel time of twenty five minutes, taking back road takes twenty four minutes and twelve seconds while taking the expressway takes thirty minutes. Therefore under the expected travel time technique taking the back road will be the best route to use because it has the least expected travel time.
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