Question 1
You want to open your own IT business. You believe that there is only a 30 percent chance of being successful. Before you make a final decision you consider doing a market research to assist you in making the final decision. Historical data shows that there is a 0.8 probability that the market research will be favorable given a successful IT business. However, there is a 0.7 probability that the market research will be unfavorable given an unsuccessful IT business.
a. Show the probabilities for: P(S1), P(I1 | S1), P(I1 | S2) (6)
b. If the market research is favorable, what is the revised probability of a successful IT business? (3)
c. If the market research is unfavorable, what is the revised probability of a successful IT business? (3)
d. What is the effect of the increased initial probability on your decision? (3)
Let :
I1: Favorable research
I2: Unfavorable research
S1: Successful IT business
S2: Unsuccessful IT business
Question 2
Jerry Smith is thinking about opening a bicycle shop in his hometown. Jerry loves to take his own bike on 50-mile trips with his friends, but he believes that any small business should be started only if there is a good chance of making a profit. Jerry can open a small shop, a large shop, or no shop at all. The profits will depend on the size of the shop and whether the market is favorable or unfavorable for his products. Because there will be a 5-year lease on the building that Jerry is thinking about using, he wants to make sure that he makes the correct decision. Jerry is also thinking about hiring his old marketing professor to conduct a marketing research study. If the study is conducted, the study could be favorable (i.e., predicting a favorable market) or unfavorable (i.e., predicting an unfavorable market). If Jerry builds the large bicycle shop, he will earn $60,000 if the market is favorable, but he will lose $40,000 if the market is unfavorable. The small shop will return a $30,000 profit in a favorable market and a $10,000 loss in an unfavorable market. At the present time, he believes that there is a 50?50 chance that the market will be favorable. His old marketing professor will charge him $5,000 for the marketing research. It is estimated that there is a 0.6 probability that the survey will be favorable. Furthermore, there is a 0.9 probability that the market will be favorable given a favorable outcome from the study. However, the marketing professor has warned Jerry that there is only a probability of 0.12 of a favorable market if the marketing research results are not favorable. Jerry is confused.
a) Draw the decision tree to represent this situation.
b) Use Expected Monetary Value (EMV) as the decision criterion. Should Jerry use the marketing research?
Answer to question 1
Answer to question 2
(a) Decision tree
Here,
UF means unfavorable,
FV means favorable
(b) Decision tree is drawn using Expecting monetary value. Expected profit as per the criteria to decide using expected monetary value is found to be $25000. To facilitate decision making Market research should be used by Jerry . Better to understand all in and out of any venture before commencing anything. As shown in the decision tree, market research opens more options to analyze the step taken accurately and further avoid any unfavorable circumstances.