Decision Making Exam 2013

University of Bath
School of Management
MN30266– Decision Making
Date and time – do not enter!
Answer any THREE questions from the five supplied
Your mark on this examination will be the mean

percentage mark for the three questions you answered
Graph paper will be supplied
Only University supplied calculators may be used
1
Question 1
A new screening test for a particular disease provides a “positive” result (i.e.
indicates that the person has the disease) for 99% of patients who have the
disease. On the other hand, the test provides a “positive” result for 1% of
patients who do not have the disease. It is known that 10% of the public have
the disease at any given time.
a). i) If a patient randomly selected from the population takes the test and
receives a “positive” result, what is the probability that they have the disease?
Use 3 decimal places.
ii) The test that is currently being used leads to a posterior probability that is
much closer to the 10% prior probability than the new test when a positive
test result for a randomly selected patient is received. Explain why this will
be.
iii) Suppose that after a preliminary examination a doctor states that he is

certain that a patient suffers from the disease. However the test gives a
negative result. What will be the doctor’s posterior probability that the patient
has the disease?
(40% of marks on question)
b) i) Each undiagnosed case of the disease costs the government £10000. On

the other hand, each “false positive” (i.e. a positive test result for an
uninfected patient) costs the government £1000 as further testing, counselling
etc. are needed. How much should the government be willing to pay for the
new test per person tested assuming that they are using the expected
monetary value (EMV) criterion?
ii) Discuss whether the EMV criterion is appropriate for the government’s
decision on whether to pay for the test.
Question 2
a) What does ‘Credence decomposition’ mean in the risk analysis literature?

Demonstrate your understanding using an example.
b) What is the rationale for using the Net Present Value (NPV) method for
appraising potential investments?
2
c) What are the limitations of using the NPV method, as it is traditionally
applied, with single figure (or ‘point’) estimates for the cash flows?
d) Outline the main steps involved in a carrying out a risk analysis using the
‘simulation’ method? You may use an example to explain these steps.
e) The following model is being used to estimate the first year sales (in
millions of units) of a potential new product, which has yet to be developed, in
order to decide whether it is worth continuing with its development.
Sales = 8 + 4 x Quality level achieved + 2x Number of sales people

employed + 1.5 x Ease of use of the product.
There is, however uncertainty about the future value of the three factors that it
is thought will determine sales. For example, the quality achieved will depend
on whether technical problems associated with the manufacturing process will
be overcome, while the number of sales people who could be appointed with
sufficient technical knowledge to sell the product is also uncertain, as is the
ease of use of the final design that will be achieved.
Quality level (in a scale of 1-25) Probability

1-5 0
6-10 0
11-15 0.3
16-20 0.6
21-25 0.1
No. of sales people employed Probability

1-10 0.1
11-20 0.1
21-30 0.3
31-40 0.4
41-50 0.1
Ease of use of final product (in a Probability

scale of 1-25)
1-5 0.1
6-10 0.2
11-15 0.3
16-20 0.3
21-25 0.1
3
You are given a three random numbers which could be used in the first run of
your simulation to estimate the product’s first year sales. The random
numbers are: 29, 67, 43.
i) Demonstrate how these random numbers can be used to estimate a

possible level of sales.
ii) What is the mechanism by which the probability distribution of the

first year sales could be obtained either manually or by using a
computer?
Question 3
The owners of a steel manufacturing facility are considering two different

alternatives to upgrade their manufacturing processes. One option is to
purchase a new Blast Oxygen Furnace (BOF), which costs £50m. The other
option is to purchase an Electric Arc Furnace (EAF), which costs £55m but is
more energy-efficient than the BOF. The owners expect that there is a 60%
chance that there will be new environmental regulations for steel
manufacturing during the lifetime of either furnace, regulations that would cost
alterations in the processes costing around £10m in the case of the BOF and
£2m in the case of the EAF.
a) Describe how you might elicit the utility function for the decision makers in
this problem. Come up with example utilities for all the possible outcomes.
b) Use a decision tree to obtain the expected utility-maximizing decision.
c) Discuss potential problems with the methodology utilised in parts (a) and
(b) in examining such a decision problem.
iii) Discuss the role that sensitivity analysis could play in this decision
Question 4
4
For each of the eight situations described below, identify why the judgments
of the managers involved may be subject to biases. (Each of the eight parts
carries an equal mark).
1. Major hurricanes occur on average only every 70 years in a region of the

USA, though their actual timing is unpredictable. Two months ago a major
hurricane caused devastation in the region. A company, which is based there
and is vulnerable to hurricane damage, has to decide whether to purchase
very expensive insurance for the next year to cover the possible losses
caused by a major hurricane.
2. Twelve companies are involved in a joint project to manufacture a new

space vehicle. The probability of any one research centre being late in the
delivery of its equipment is thought to be 10%. A manager has to assess the
probability that at least one research centre will deliver its equipment late.
3. A company at the cutting edge of chemical technology has to carry out

experiments that can potentially cause injury and damage if a complete set of
safety measures has not been put in place. Before carrying out the
experiment 100 independent safety checks have to be made. The probability
that each check will be conducted correctly is thought to be 99.2%. The test-
centre manager has to assess the probability that all 100 checks will be
carried out correctly.
4. A large electronics company has an Approval Panel whose role is to

determine whether products should be commercialised following their
technical development. Around 25 potential products are developed each year
but the committee considers each product separately and assesses the risk
that it will be a commercial failure. Most products are rejected because the
committee is unwilling to take the risk.
5. As part of a planning process, managers have to assess which of the

following scenarios is most probable.
Scenario A: Increased centralisation of the Euro Zone by 2016 with

individual member governments conceding fiscal decision
making to a central body in Brussels as a result of a
default on debt repayments by Spain, Italy or Greece.
Scenario B: Increased centralisation of the Euro Zone by 2016 with

individual member governments conceding fiscal decision
making to a central body in Brussels
5
6. Only 25 % of the products launched onto the market by a company are
economic successes and survive in the market for more than a year. The
chances of any product being successful are thought to be independent of
what happens to other products. Remarkably, the last six products developed
by the company have been successful. One manager points out that the
chances of a run of success like this are about 2 in 10000. His colleague now
has to assess the probability that the latest product, which is due to be
launched next month, will be successful and hence will still be on the market a
year after its launch.
7 A company has been losing customers to a rival for several years and has
to decide whether to undertake a rebranding of its products in an attempt to
stop the decline. It is thought that, if nothing is done, another 3000 customers
will be lost this year. However rebranding is a risky strategy and it is estimated
that it will have a 30% chance of ensuring that no further customers are lost
this year, but a 70% chance that it will worsen the situation and lead to the
loss of 6000 customers.
8. A forecaster has to predict next year’s sales of a product. He first estimates

that the most likely level of sales is 2300 units. He then makes an optimistic
estimate that sales will reach 2700 units and a pessimistic estimate that they
will only reach 1900 units. He states that he is 90% confident the actual level
of sales will fall between his pessimistic and optimistic estimates.
Question 5
Do groups of people tend to make better decisions than individuals? Give

reasons for your answer.

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University of Bath

MN30266– Decision Making

Date and time – do not enter!

Answer any THREE questions from the five supplied

Your mark on this examination will be the mean

Graph paper will be supplied

Only University supplied calculators may be used

iii) Suppose that after a preliminary examination a doctor states that he is

(40% of marks on question)

b) i) Each undiagnosed case of the disease costs the government £10000. On

(60% of marks on question)

a) What does ‘Credence decomposition’ mean in the risk analysis literature?

(15% of marks on question)

(15% of marks on question)

(30% of marks on question)

Sales = 8 + 4 x Quality level achieved + 2x Number of sales people

Quality level (in a scale of 1-25) Probability

No. of sales people employed Probability

Ease of use of final product (in a Probability

i) Demonstrate how these random numbers can be used to estimate a

ii) What is the mechanism by which the probability distribution of the

(25% of marks on question)

The owners of a steel manufacturing facility are considering two different

(40% of marks on question)

b) Use a decision tree to obtain the expected utility-maximizing decision.

(30% of marks on question)

(30% of marks on question)

1. Major hurricanes occur on average only every 70 years in a region of the

2. Twelve companies are involved in a joint project to manufacture a new

3. A company at the cutting edge of chemical technology has to carry out

4. A large electronics company has an Approval Panel whose role is to

5. As part of a planning process, managers have to assess which of the

Scenario A: Increased centralisation of the Euro Zone by 2016 with

Scenario B: Increased centralisation of the Euro Zone by 2016 with

8. A forecaster has to predict next year’s sales of a product. He first estimates

Do groups of people tend to make better decisions than individuals? Give

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