Stats Report

Topics: Decision theory, Decision making, Decision tree Pages: 9 (1770 words) Published: April 27, 2011
Case Study: Property Purchase Strategy

Main Report 3
Introduction3
Decision Analysis 3
Increasing the expected payoff 5
Conclusion 5
Appendix6
Decision Tree6
Calculation of probabilities 7
Calculation of expected payoff8
Relationship between the expected payoff and amount of bid9

Introduction
Decision analysis is an integral and powerful component in the decision making process, and can be used to determine the optimal decision alternative according to the criterion set by the business by objectively assessing the complicating factors and underlying issues of each decision. In this case study, the analysis of the problems faced by Oceanview Development Corporation will start off with a decision tree showing the logical sequence of the decision problem. We will then recommend whether or not Oceanview should conduct market research. Evaluative points of the analysis will be provided, discussing inherent weaknesses of the analysis and a novel alternative solution will be provided. Decision analysis

In a decision tree, the decision nodes are represented by numbered squares and the chance nodes, by numbered circles. The branches denote the sequential nature of the decision making process. To make the optimal decision, this sequence of events must first be determined, together with the probabilities of states of nature and the expected values at the chance nodes. The optimal decision can then be made by selecting the decision branch that will lead to the highest payoff value at the chance node. If Oceanview does not conduct market research, it will have to decide whether to bid in the absence of market research information. If it decides not to, it will incur no loss nor make any gains, but if it decides to bid, it will have a probability of 0.2 of winning the bid. If it does not win, the bid will be recovered and no loss will be incurred, but if it wins, its payoff then depends on whether the referendum for zoning change is approved. It will lose the deposit of \$500,000 if it is rejected (probability of 0.7) but make a profit of \$2 million if it is accepted (probability of 0.3). If Oceanview bids, the expected payoff of \$50,000 is greater than that of \$0 if it does not bid. Hence it should proceed with the bid. However, if Oceanview conducts market research, its decision will be based on the study. If approval is predicted, it will have to decide whether to bid and this decision will hinge largely on its perceived reliability of the market research. If it decides not to bid, it will incur a loss of \$15,000 from the cost of the research. If it bids, and loses, the outcome will be similar since the bid will be recovered. However, if it wins the bid, its payoff will depend on whether the zoning change is approved. If the zoning change is rejected (probability of 0.3415, given that the market research predicts approval), Oceanview will incur a loss of \$515,000, which is undesirable. However, if the zoning change is approved (probability of 0.6585, given that the market research predicts approval), it will earn \$1,985,000. Hence, in deciding whether to bid, it will have to consider whether it is willing to take a higher risk (losing the deposit) in view of the opportunity to make more profits. If approval is predicted (probability of 0.59) and Oceanview bids, the expected payoff is \$214,250, while that if it does not bid is a loss of \$15,000. Hence if it conducts market research, and approval is predicted, it should bid. If rejection is predicted (probability of 0.41) it will have to decide whether to bid based on market information. If it decides not to bid, it will incur a loss of \$15,000 due to the cost of market research, but if it bids, its expected payoff will depend on whether it wins the bid, and whether the zoning change is approved. If it does not win, its bid will be refunded and hence it incurs only the market research cost of \$15,000. However, if it does win the bid, its payoff will...