Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 1

Decision Trees

Used for complex decision problems characterized by uncertainities Two main symbols: Box = Decision Circle = Random event Expected profit values calculated Select decision with highest exp. profit

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 2

An Example

A glass factory specializing in crystal is experiencing a substantial backlog, and the firm's management is considering three courses of action:

A) Arrange for subcontracting,B) Construct new facilities.C) Do nothing (no change)

The correct choice depends largely upon demand, which may be low, medium, or high. By consensus, management estimates the respective demand probabilities as .10, .50, and .40.

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 3

The Payoff Table

0.1 0.5 0.4Low Medium High

A 10 50 90B -120 25 200C 20 40 60

The management also estimates the profits when choosing from the three alternatives (A, B, and C) under the differing probable levels of demand. These costs, in thousands of dollars are presented in the table below:

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 4

Step 1: Draw the decisions

A

B

C

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 5

Step 2: Draw the random events

A

B

C

High demand (.4)

Medium demand (.5)

Low demand (.1)

$90k$50k

$10k

High demand (.4)

Medium demand (.5)

Low demand (.1)

$200k$25k

-$120k

High demand (.4)

Medium demand (.5)

Low demand (.1)

$60k$40k

$20k

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 6

Step 3: Calculate exp. valuesHigh demand (.4)

Medium demand (.5)

Low demand (.1)

A

$90k$50k

$10k

EVA=.4(90)+.5(50)+.1(10)=$62k

$62k

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 7

Step 4: Select best alternativeHigh demand (.4)

Medium demand (.5)

Low demand (.1)

High demand (.4)

Medium demand (.5)

Low demand (.1)

A

B

CHigh demand (.4)

Medium demand (.5)

Low demand (.1)

$90k$50k

$10k

$200k$25k

-$120k

$60k$40k

$20k

$62k

$80.5k

$46k

Alternative B generates the greatest expected profit, so our choice is B or to construct a new facility.

Operations Management For Competitive Advantage

©The McGraw-Hill Companies, Inc., 2001CHASE AQUILANO JACOBS

ninth edition 8

Other views and criteria

Sensitivity analysis for the estimated probabilities

Can we “buy” better information? EVPI Risk Aversion, Utilities