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Q68 refers:
A company wishes to go ahead with one of three mutually exclusive projects, but the profit outcome from each project will depend on the strength of demand as follows:
Project 1: Strong demand – Profit 70000; Moderate demand – 10000; Weak – (7000)
Project 2: Strong demand – Profit 25000; Moderate demand – 12000; Weak – 5000
Project 3: Strong demand – Profit 50000; Moderate demand – 20000; Weak – (6000)Probability of demand: Strong demand 0.1; Moderate demand 0.4; Weak demand 0.5
The way I reasoned it out was as follows:
first I worked the EVs of profit for all the 3 projects at the different levels of demand (strong, moderate and weak). This gave me the project to be selected based on highest EV. But then couldn’t figure out how to continue…
I do not understand how the answer takes both the EVs of project 1 and project 2 and calls it EV with perfect information and compares them to the EV of project 3 without perfect information.
Can you explain please?
Thanks
Without perfect information then Project 3 is best and the EV is 10,000.
With perfect information, if demand is strong they choose 1 and get 70,000; if demand is moderate they choose 3 and get 20,000, and if demand is weak they choose 2 and get 5,000.
So the EV with perfect information is the expected value of those three returns using the probabilities given.I suggest that you watch my free lectures on dealing with risk and uncertainty because I do explain how to calculate the benefit of perfect information. (My lectures are a complete free course for Paper F5 and cover everything needed to be able to pass the exam well)
Hi Mr Moffat,
I have listened to your lectures and have worked a lot of minimax/maximax/EV/minimax regret questions and can work them reasonable well. However I would like to understand how the answer on the revision kit Pg 107 of BPP for Q103 takes the total of the regret for each level of bags. The previous question, No 98 shows the answer on pg 106, takes only the minimax regret for each price level, and there are no additions for regrets!
Q103 is found on pg29 and Q98 on pg28.
Thanks
I don’t know what you mean by “no additions for regrets”.
For Q103, if demand is ‘good’ then the best choice would be 350,000 giving a pay-off of 1,750. So if they chose 350,000 there would be 0 regret.
Whereas if they had chosen 280,000 then the pay-off would only be 1,400 and therefore there would be regret of 1750 – 1400 = 350
And the same approach for all of them.For Q98, the approach is exactly the same.
If the variable cost is $170, then the best choice would be a selling price of $425 giving a pay-off of 255,000. So if they chose 425 there would be no regret.
Whereas if they had chosen a price of 500, the payoff would only be 240,900 and therefore there would be regret of 255,000 – 240,900 = 14,100.
And again similarly for all of the others.I followed your same reasoning in arriving at the answer. However, The answer for Q103 shows that the minimax regrets for each were added! Hence my confusion… Would love to send you a pic of the answer if this was possible!
Anyhow, thanks as always 🙂
I have the answer, and sorry – now I see what you mean!
Although the regret table is correct, the rest of the answer is complete rubbish!
The maximum regrets are:
350,000 $675
280,000 $360
200,000 $750Therefore they should choose 280,000 because that is the minimum at $360.
(They coincidentally end up with the correct answer (280,000) but for completely the wrong reasons 🙂 )
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