MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012 1 TAKE-HOME FINAL EXAMINATION – MS&E 52, SUMMER 2012 Due Saturday, 18 AUG, 10:00pm (sharp!) in your personal Drop Box on Coursework. Any late exam, even by a few minutes, will receive at most half credit. Work on this exam individually. You may use any resources other than consulting another person or previous years’ exams or solutions. Please affirm that you have complied with the requirements of the Stanford Honor Code by typing your name and Student ID number in the spaces provided below. The exam will not be graded unless the honor code is affirmed. Please read the entire exam first. Use the Coursework Forum to ask any questions of clarification. However, posting answers or anything that could be perceived as a hint to anyone reading the post will be considered a violation of the honor code. Your questions will be answered until midnight tonight, 15 AUG. After that you will be on your own. Place all answers in the boxes provided. No credit will be given for answers outside the boxes. Any detailed work or calculations that you would like to provide for possible additional credit should be placed at the end of the exam. Your final document should be a Word or PDF file. You may paste diagrams or charts from PowerPoint or Excel, or you may use the graphic functions available in Word. Please avoid using photos from your phone or camera. Be sure the document that you submit is readable and clear. The maximum number of points you can receive on this exam is 400 out of total possible of 440 points. These extra points give you a 10 % cushion. Good luck! Last Name: Ruelas Martinez First Name: Andres Daniel In recognition and in the spirit of the Honor Code, I certify that I have neither received nor given unpermitted aid on this exam and that I have reported, to the best of my ability, all Honor Code violations observed. Student ID Number: 005848788
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MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
1
TAKE-HOME FINAL EXAMINATION – MS&E 52, SUMMER 2012
Due Saturday, 18 AUG, 10:00pm (sharp!) in your personal Drop Box on Coursework.
Any late exam, even by a few minutes, will receive at most half credit.
Work on this exam individually. You may use any resources other than consulting another person or previous years’
exams or solutions.
Please affirm that you have complied with the requirements of the Stanford Honor Code by typing your name and Student
ID number in the spaces provided below. The exam will not be graded unless the honor code is affirmed.
Please read the entire exam first. Use the Coursework Forum to ask any questions of clarification. However, posting
answers or anything that could be perceived as a hint to anyone reading the post will be considered a violation of the
honor code. Your questions will be answered until midnight tonight, 15 AUG. After that you will be on your own.
Place all answers in the boxes provided. No credit will be given for answers outside the boxes. Any detailed work or
calculations that you would like to provide for possible additional credit should be placed at the end of the exam.
Your final document should be a Word or PDF file. You may paste diagrams or charts from PowerPoint or Excel, or you
may use the graphic functions available in Word. Please avoid using photos from your phone or camera. Be sure the
document that you submit is readable and clear.
The maximum number of points you can receive on this exam is 400 out of total possible of 440 points. These extra
points give you a 10 % cushion.
Good luck!
Last Name: Ruelas Martinez
First Name: Andres Daniel
In recognition and in the spirit of the Honor Code, I certify that I have neither received nor given unpermitted aid on this
exam and that I have reported, to the best of my ability, all Honor Code violations observed.
Student ID Number: 005848788
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
2
Question 1: Tornado Inc.’s Decision (240 points)
You did a great job in Homework 4 for your client, Tornado Inc., the touch-screen tablet manufacturer. So, they
decided to continue working with you on their production decision. To refresh your memory, Tornado Inc. is
launching its newest product, the tPad, and the CEO must decide how many to produce. They previously had
uncertainty about many of the key profit drivers. But now, after thorough research on production costs and
competitive prices, they no longer have any uncertainty regarding fixed production costs, variable production
costs, or tPad price, as summarized in the following table:
Production
Decision
(millions)
Fixed
Production
Costs
($ millions)
Variable
Production
Costs
($/unit)
tPad Price
($/unit)
12 240 15 150
8 100 20 150
4 60 25 150
However, the uncertainty on tPad market demand is still troubling them, where tPad market demand is the
product of overall market size and Tornado Inc.’s market share. The CEO, after consulting with an expert he
trusts, believes that the probability of tPad market demand being 5 million is 60%, and that the probability of
tPad market demand being 10 million is 40%. Tornado Inc. must pay the variable costs for all of the tPads that
it decides to produce because this decision is made before any market demand is realized. The profit of Tornado
Inc. for each level of production is then calculated using the following formula:
Each of the following questions can be answered independently of the others.
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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a) Draw a decision diagram for Tornado Inc.’s problem. Include only uncertainties, decisions, values, and
relevance relationships. (Remember that the fixed and variable costs as well as tPad price are no longer
uncertainties; they are now calculations included in the definition of profit.) (40 points)
Production
Profit
Market Demand
Demand
Market Size /
Market Share
Costs
Variable & Fixed
Price
Revenues
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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Production
12 million
60%
5 million $330 millions
40%
10 million 1,080 millions
8 million
60%
5 million $490 millions
40%
10 million $940 millions
4 million
60%
5 million $440 millions
40%
10 million $440 millions
b) Draw the decision tree for Tornado Inc.’s decision and evaluate it. (40 points)
Table with Calculations in Appendix
Recommended
production
level and its
expected
value
We recommend to produce 8 million of tPad’s, and its expected value is $670
million
Production
Demand Value
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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Demand
40%
High
60%
High 24%
40%
Low 16%
60%
Low
20%
High 12%
80%
Low 48%
Demand
36%
High
66%
High 24%
34%
Low 12%
64%
Low
25%
High 16%
75%
Low 48%
c) Mr. Experto called the CEO and offered to predict the market demand (high or low) for $40 million.
The CEO believes that Mr. Experto’s prediction will correctly predict demand with 60% probability if
demand turns out to be high, and with 80% probability if demand turns out to be low. Should he accept
Mr. Experto’s offer? Why or why not? Be sure to say what decision, if any, switches with this
prediction. Hint: You will need to flip a tree. (40 points)
Accept Mr. Experto’s Offer (circle one) Yes No
Demand
High
60%
High
40%
Low
Low
20%
High
80%
Low
Market Test
Assessment Order
Evaluation Order
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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$684.40 Value with the imperfect prediction
$670.00 Value without the imperfect prediction
__________
$12.50 Value of the Imperfect Prediction
So, they shouldn’t accept Mr. Experto’s offer, because the most that the company is willing to pay for a prediction is $12.50, and $40 million it’s out of the bucket.
Also now the best is going for the large production.
Table with Calculations in Appendix
$682.60
High
36%
Large
High
66% $1,080
Low
34% $330
Medium
High
66% $940
Low
34% $490
Small
High
66% $440
Low
34% $440
Low
64%
Large
High
25% $1,080
Low
75% $330
Medium
High
25% $940
Low
75% $490
Small
High
25% $440
Low
75% $440
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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d) Later that day, Ms. Wizardette approaches the CEO and offers to guarantee high market demand
(10 million units) for $100 million. If he believes that Ms. Wizardette can deliver on this guarantee with
no unanticipated side effects, should he accept the offer? Why or why not? Be sure to say what
decision, if any, switches with this guarantee. (40 points)
Accept Ms. Wizardette’s Offer? (Circle one) Yes No
Yes, we should accept the deal.
Because, if he guarantee a high market demand, you know that the best would be to produce 12,000,000
million units (Large production); and that gives a profit of $1,080 million.
We know that the value without perfect information is = 670 million, (Given in question 1b), so:
Value with perfect information = $1,080 million
- Value without perfect information = $670 million
______________________________________________
Value of the information = $470 million
Now we know that the value of the information it’s equal to $470 million, and Ms Wizardette it’s only
charging for that information $100 million.
So definitely, the CEO should take that offer, without doubt.
And also, the decision of production changes: Instead of medium (8 million), now they should produce
large (12 million).
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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$1080
High
Large High $1,080
Low $330
Medium High $940
Low $490
Small High $440
Low $440
Low
Large High $1,080
Low $330
Medium High $940
Low $490
Small High $440
Low $440
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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e) The US government is considering upgrading part of its Information Technology (IT) infrastructure. So,
it approached Tornado Inc. with a proposal for a futures contract whereby the US government would
promise to buy 2 million tPads in the future for a price of $20/unit, regardless of market demand.
Should Tornado Inc. accept this deal? Tornado Inc. counter-proposed a future price of $50/unit. Would
this be a good deal for Tornado Inc.? Why or why not? Would their production decision change?
(40 points) Hint: In this case, the profit is calculated using this revised formula:
They should be indifferent from this deal, because it’s the same expected value than question 1b,
($670 million); but now it changes that the production has to be Large (12 million), instead of
Medium (8 million). So, there’s no problem if they accept the deal or not.
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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If the price goes up to $50 instead of $20, the profit would be greater. So, this is the option that Tornado Inc. should go for, because, they now can get a profit of $730 million, instead of $670 million. They should go for this deal.
And now, the production should be large (12 million), instead of medium (8 million).
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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-$30 million
Major Damage
5% -$500 million
Minor Damage
10% -$50 million
No Damage Loss
85% $0 million
f) Tornado Inc. is a multinational corporation and most of its manufacturing is conducted outside the U.S.
Because Tornado Inc.’s main market is in the U.S., the company needs to use international
transportation to ship its products, which involves some risk. Prior to the company shipping $500
million worth of tPads to the U.S., the CEO has the opportunity to buy an insurance policy against
accidental loss. He believes that the probability of major damage occurring is 5% and, if so, Tornado
Inc. would experience a total loss of the $500 million shipment, He also believes that minor damage will
result in a loss of $50 million and is twice as likely to occur as major damage. In all remaining
scenarios, Tornado Inc. would experience no damage loss. If Tornado Inc. purchases insurance and
damage occurs, then the company would be liable for the first $100 million of losses and the insurance
company would reimburse the company for all losses over this deductible amount. What is the most that
the CEO should be willing to pay for insurance on this shipment? Why? (40 points)
Most to pay for Insurance Less than $20 million
Why?
Without Insurance
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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-$10 million
Major Damage
5%
-$500 million + $400 million
Minor Damage
10% -$50 million
No Damage Loss
85% $0 million
Value without perfect information $-10 million
Value with perfect information $-30 million
_______________________________________
Value of information: (-10) – (-30) = $20 million
So the most that the CEO should be willing to pay is $20 million. Why? Because the Expected value without the insurance is a loss of $-30 million, and with the insurance is $-10 million.
So the difference is $20 million, but a deal less than that amount would be perfect.
With Insurance
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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Question 2: Personal Decision (150 points)
Throughout MS&E 52 you have learned to use several tools for framing, structuring, modeling, and analyzing a
decision situation. Select a personal decision situation that you are currently facing, or will be facing in the near
future. Personal decisions might be, but are not limited to: choosing a college to attend, applying for a job or
switching to a new job, joining a professional athletic team, buying a car, treating a medical problem, or
investing your financial resources. You are free to consider any personal decision situation as long as it does not
fall in the Autopilot Zone or the Routine Zone, and as long as you have not already made the decision. Please
be clear, concise, and incisive; bullet points may work better than essay paragraphs.
a) Briefly describe your decision. State who the decision makers are and who is affected by the decision.
List several aspects for both the upside and the downside of possible courses of action. Describe key
technical complexities and organizational complexities of your decision. (20 points)
My decision is if I’m going to transfer to a different college in Mexico or not. I’m going to enter to College this
September in Mexicali, Mexico (city) and after my first semester I have to decide whether if I’m going to Monterrey,
Mexico to continue my studies, or staying in my city.
Decision Makers: My dad and I
Affected: My family, my girlfriend and I
Organizational Complexities (High)
The school that I’m thinking to transfer is more expensive, and I also will have to pay rent or boarding
In that kind of cases, my dad always have the final word
We have different interests, and we think different about the value of staying or leaving
Mentality to be worried about being away from the family
Technical / Data Complexities (High)
Decide between 2 colleges and 15 different majors (Only in Engineering)
Uncertainty about the scholarship that I could receive
Both schools are very recognized, but my personal opinion is influenced about what my friends said about that
school
Uncertain about the rent of the house, possibility to don’t like the school
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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b) List three to five key decisions (over which you have control) and three to five key uncertainties (over
which you do not have control.) (10 points)
Decisions
To choose between Tec de Monterrey or Universidad de Monterrey
The major that I’m going to pick in the Engineering School
To live in a department or in the school
Uncertainties
The price of the school, it’s getting more expensive each year
The security in Monterrey
The scholarship that I’m going to receive
The subjects that I’m going to transfer from my old College
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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c) Describe your decision situation with a decision hierarchy. Include three to five entries at each level and
ensure that all of your entries are decisions (commitments to irrevocably allocate valuable resources) --
not goals, wishes, information, or preference statements. (20 points)
GIV
EN
FOCUS
LATER
I will study in an Engineering School My College fund is $20,000 per year I will start college this August I will start the transfer application in
November
What major I’m going to pick? Live in department, in the school? What school I’m going to attend? Study scholarship or sport
scholarship?
Exchange to another university in Europe
Where I’m coming back to my hometown?
Join any group? Partial job while
studying?
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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d) Use a strategy table to identify three significantly different yet potentially attractive strategies for your
decision. Ensure that your strategy table is consistent with other steps of your analysis. (30 points)
Strategy
Decisions School Major Scholarship Housing
I don’t want to
leave my
hometown
CETYS
University (my
old college)
Mechanical None Department
This is what I
want?
Tec de
Monterrey Biomedical Sport (Soccer)
School
Trust me, I’m
an Engineer
Universidad de
Monterrey
Management
Sciences &
Engineering
Academics My house in
Mexicali
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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e) Draw a decision diagram for your decision. Remember that uncertainties with relevance arrows pointing
to decisions must be known with 100% certainty before that decision is made. Ensure that your decision
diagram is consistent with other steps of your analysis. (30 points)
Which College
attend?
Department
of study
College
Fund
Scholarship
Security
Cost of each
course
Major
University
Costs
Part time job
(internship)
$$$
Real Cost
of College
Housing
Courses
City to Study
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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f) Provide concise and insightful answers to the following questions. (30 points)
1) Define the possible outcomes for each of your uncertainties.
2) List a total of four cognitive and/or motivational biases that you are concerned might affect your
subjective judgments about these uncertainties. Explain each.
3) How will you deal with each of these biases?
4) What sources of expertise will you use in making your probability assessments?
5) What probabilities are you currently assigning to each possible outcome for each uncertainty?
1) For my scholarship, I could receive a sports scholarship, academic, or none. In the case of university costs,
they may change each semester, so probably it would be more expensive. The security of a city is very
unpredictable it could be very insecure or secure, so that may change my opinion at the moment of choosing the
city to study. After choosing the major, there is a possibility that they could charge me for courses, or for year,
so the cost of the academic charge is uncertainty. Depending on what focus I want to give to my studies, my
first job should be related with my major, but whether I can get paid, or not for that job.
I already know the department of study (Engineering), and the College Fund that I have for my education, so
this “uncertainties” affect my decision directly.
2) Availability: A lot of friends just started college in both schools, and they are telling me that it’s awesome, and
that I should come with them to continue my studies.
Representativeness: So he is graduated from that school, he should be successful. Or he is successful; he should
be graduated from that school. These statements are so wrong, but are in my head.
Misaligned Incentives: If I get the better grades, and change my school as a reward for my grades, I would be
very happy.
Anchoring: I’m guessing about the quality of my original College in my hometown, despising their quality.
3) For the availability, I would search for reliable information, actual and from the last few years, about the quality
of the school, the teachers and how are they in the field that I want to focus. For representativeness, I should
not generalize every people who graduate from those schools, they might be successful, or they might not. For
the misaligned incentives, it’s a reward for me going to that schools, so, the probabilities that I think that it
would happen, depends on my “state of humor”, so, to deal with that, I have to stop thinking like that, and see it
like a goal, a dream, instead of a reward. And for anchoring, stop guessing about the quality and start looking
for official documents that describe how my school is, ask people who went there and are there, and stop being
nervous about that.
4) I will use for example, for the scholarship; I will compare how many students receive sports scholarships, and
how many receive academy, and what they did to get that scholarship. After that, I will compare their situation
with mine, to see how close I am to receive any kind of scholarship. For the uncertainty of the university cost, I
MS&E 52: Introduction to Decision Making. Final Exam. Summer 2012
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will talk to the dean of admissions and financial aid, to see how is increasing the costs each year, and what are
the possibilities that the cost will be out of my budget. For the security, I will check in the news, different
newspapers, webpages, radio, too see the different points of view of each kind of media, and also, contact my
friends and family that I have in Monterrey, to ask for their advice. For the part time job, that’s a big
uncertainty whether I going to get paid or not. For that, I will ask first the companies that I want to do an
internship, to see if they accept students. After that, I will ask if they paid or not (That’s not a relevant situation,
if the company is really good, and I want to do my practice there). To finish, I will look for people that I know
that are working in “x company” that I want to do my internship (depending of my major), and ask how are the
conditions of working, and if my major it’s relevant for the company policy.