Acct 306: Ragsdale Chapter 14 Decision Analysis
How do you find the payoff value??
Present value of future cash flows if built at said location minus current purchase price
A decision must involve at how many alternatives for addressing or solving a problem?
Two
What is maximax decision rule?
which determines the maximum payoff for each alternative and then selects the alternative associated with the largest payoff.
What is the payoff matrix?
A payoff matrix is a table that summarizes the final outcome (or payoff) for each decision alternative under each possible state of nature.
What is an alternative in the context of decision making?
An alternative is a course of action intended to solve a problem. (Ex: You could accept the offer from company A, accept the offer from company B, or reject both offers and continue searching for a better one.)
What is an example of maximin decision in the context of the example used in the textbook?
Column D in Figure 14.4 lists the minimum payoff for each alternative. The largest (maximum) value in column D is the payoff of $0 associated with not buying any land. Thus, the maximin decision rule suggests that Magnolia Inns should not buy either parcel because, in the worst case, the other alternatives result in losses, whereas this alternative does not.
What is an example of opportunity loss?
For example, suppose that Magnolia Inns decides to buy the parcel of land at location Aas suggested by the maximax decision rule. If the airport is built at location A, the company will not regret this decision at all because it provides the largest possible payoff under the state of nature that occurred. However, what if the company buys the parcel at location A and the airport is built at location B? In this case, the company would experience a regret, or opportunity loss, of $23 million. If Magnolia Inns had bought the parcel at location B, it would have earned a payoff of $11 million, and the decision to buy the parcel at location A resulted in a loss of $12 million. Thus, there is a difference of $23 million in the payoffs between these two alternatives under this state of nature.
What is an example of criteria?
For example, the criteria used to evaluate the job offer alternatives might include starting salary, expected salary growth, desirability of job location, opportunity for promotion and career advancement, and so on.
How about if both locations are purchased and built at location A? What is the payoff value then?
Present value of future cash flows if hotel and airport are built at location A plus present value of future sales price for the unused parcel at location B minus current purchase prices of A and B combined
Alternatives are evaluated on the basis of the value they add to one or more decision criteria. What is criteria?
The criteria in a decision problem represent various factors that are important to the decision maker and influenced by the alternatives.
Finally, the values assumed by the various decision criteria under each alternative depend on the different states of nature that can occur. What is states of nature?
The states of nature in a decision problem correspond to future events that are not under the decision maker's control. (For example, company A could experience spectacular growth, or it might go bankrupt. Each of these contingencies represents a possible state of nature for the problem. Many other states of nature are possible for the company; for example, it could grow slowly or not grow at all.)
How is the maximin decision rule applied?
We first determine the minimum possible payoff for each alternative and then select the alternative with the largest minimum payoff (or the maximum of the minimum payoffs—hence the term "maximin").
What is the maximin decision rule and why is it considered conservative?
it pessimistically assumes that nature will always be "against us" regardless of the decision we make. This decision rule can be used to hedge against the worst possible outcome of a decision.
Another way of approaching decision problems involves the concept of regret, or what is the synonym of regret in this context of minimax?
opportunity loss.
What is an example of the maximax decision rule?
the largest possible payoff will occur if the location A parcel is bought, and airport is built there. So if the company believes that nature will always be "on its side" regardless of the decision it makes, the company should buy location A as it leads to the largest possible payoff.
How are decision rules divided into two categories?
those that assume that probabilities of occurrence can be assigned to the states of nature in a decision problem (probabilistic methods), and those that do not (nonprobabilistic methods).
