Sensitivity Analysis and Decision Trees
37 Questions
0 Views

Sensitivity Analysis and Decision Trees

Created by
@SprightlyFoxglove

Podcast Beta

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What does EMV stand for in the context of decision trees?

  • Economic Market Value
  • Expected Monetary Value (correct)
  • Estimated Money Value
  • Efficient Money Variance

    • What is the expected monetary value (EMV) of Investment A?

  • 10,000 AZN
  • 6,000 AZN
  • 7,500 AZN
  • 8,000 AZN (correct)

    • In what direction do you work when calculating EMVs using the folding-back process in decision trees?

  • Left to right
  • Upward
  • Right to left (correct)
  • Downward

    • What was the calculated utility of Investment A?

    <p>172.25</p> Signup and view all the answers

    What is represented by the 'spike' chart known as the risk profile?

    <p>Probability distribution of monetary outcomes</p> Signup and view all the answers

    In what percentage of business decision analyses is risk aversion considered a practical concern?

    <p>5% to 10%</p> Signup and view all the answers

    What do you do at each decision node when identifying the optimal decision?

    <p>Take a maximum of EMVs</p> Signup and view all the answers

    Which utility value corresponds to the highest cash inflow for Investment B?

    <p>194</p> Signup and view all the answers

    Which of the following costs is associated with preparing a bid according to the example provided?

    <p>$5,000</p> Signup and view all the answers

    What might be a more common approach than expected utility maximization in business decisions?

    <p>Expected value (EMV) calculations</p> Signup and view all the answers

    What role does the PrecisionTree add-in serve in the context of decision trees?

    <p>Conducts the folding-back calculations</p> Signup and view all the answers

    If there is a 30% chance that there will be no competing bids, what is the implication on the decision-making process?

    <p>Consideration of opportunity costs in bidding is vital</p> Signup and view all the answers

    Which of the following best describes the calculation of EMVs at chance nodes?

    <p>A product of monetary values and probabilities</p> Signup and view all the answers

    What is the primary purpose of conducting sensitivity analysis in decision analysis?

    <p>To assess how changes in inputs affect outputs</p> Signup and view all the answers

    Which component of a decision tree represents a point where a decision is made?

    <p>Decision node</p> Signup and view all the answers

    In a decision tree, what does a chance node signify?

    <p>An uncertain outcome for which probabilities are known</p> Signup and view all the answers

    How do the branches of a decision tree function in terms of decisions and outcomes?

    <p>Branches from decision nodes represent possible decisions to choose from</p> Signup and view all the answers

    What is indicated by an end node in a decision tree?

    <p>The completion of all decisions and the realization of outcomes</p> Signup and view all the answers

    When should probabilities be assigned to branches in a decision tree?

    <p>After observing past outcomes</p> Signup and view all the answers

    What is the sequence direction in a decision tree?

    <p>Left to right</p> Signup and view all the answers

    Why is a sensitivity analysis considered crucial in real-world business problems?

    <p>It verifies the robustness of decisions under varying scenarios</p> Signup and view all the answers

    What does EVSI represent in terms of sample information?

    <p>The most you would be willing to pay for sample information.</p> Signup and view all the answers

    What condition must hold for a decision maker to consider purchasing information?

    <p>The actual price of the information should be less than or equal to the expected EMV increase.</p> Signup and view all the answers

    Which statement regarding the value of information is true?

    <p>Information that does not eliminate uncertainty has no value.</p> Signup and view all the answers

    How do most individuals typically respond to risk, according to the content?

    <p>They are usually risk averse, sacrificing EMV to avoid risk.</p> Signup and view all the answers

    What is the main purpose of a utility function in decision-making?

    <p>To transform monetary values into utility values.</p> Signup and view all the answers

    Which of the following statements best describes expected utility maximizers?

    <p>They occasionally sacrifice EMV to minimize potential risks.</p> Signup and view all the answers

    What does the expected value of perfect information (EVPI) indicate?

    <p>The maximum price one would pay for flawless information.</p> Signup and view all the answers

    Which type of utility functions has been created to evaluate individual risk preferences?

    <p>Exponential utility functions.</p> Signup and view all the answers

    What does the risk tolerance parameter in an exponential utility function represent?

    <p>An individual's aversion to risk</p> Signup and view all the answers

    How is the risk tolerance of Venture Limited defined in the example?

    <p>$1.92 million of its net sales</p> Signup and view all the answers

    Which outcome has the highest probability in the less risky venture for Venture Limited?

    <p>$0.1 million gain</p> Signup and view all the answers

    In an exponential utility function, which of the following statements is true regarding risk tolerance?

    <p>It is a single numeric value defining risk perception</p> Signup and view all the answers

    What is a characteristic of an exponential utility function?

    <p>It has only one numerical parameter for risk tolerance</p> Signup and view all the answers

    Which of the following best describes the outcomes of the more risky venture for Venture Limited?

    <p>Outcomes are more diverse with a higher potential loss</p> Signup and view all the answers

    Based on the example, what is the sure gain offered to Venture Limited?

    <p>$125,000</p> Signup and view all the answers

    Which of the following outcomes has the lowest probability in the more risky venture?

    <p>$3 million gain</p> Signup and view all the answers

    Study Notes

    Sensitivity Analysis

    • It is important to analyze the sensitivity of the data used in decision models
    • Sensitivity analysis examines how outputs, such as EMVs and the preferred decision, change in reaction to variations in the input variables.

    Decision Trees

    • Decision trees are visual tools for representing decision problems
    • They illustrate the sequence of events, including decisions, outcomes, probabilities, and monetary values
    • Nodes are points in time represented by circles (chance nodes), squares (decision nodes) and triangles (end nodes)
    • Branches depict possible choices, uncertain outcomes, probabilities and monetary values
    • Probabilities on branches leaving chance nodes must always add up to 1
    • The expected monetary value is calculated using a folding-back process

    Risk Profiles

    • A risk profile shows the probability distribution of monetary outcomes for a given decision using a spike chart
    • It helps visualize the risks and rewards associated with a specific decision
    • Comparing risk profiles for multiple choices reveals their relative strengths and weaknesses

    Example 6.1: SciTools Bidding Decision

    • SciTools must decide whether to bid on a government contract
    • They need to consider estimated low bids from competitors and their associated probabilities
    • Additionally, they must factor in the cost of preparing a bid and the cost of supplying the instruments

    The Value of Information

    • The expected value of sample information (EVSI) is the maximum amount one would pay for additional information
    • The expected value of perfect information (EVPI) is the maximum one would pay for perfect information that eliminates all uncertainty
    • The value of information is directly related to its potential to increase decision-making accuracy and benefit
    • Information that doesn't influence a decision is considered worthless

    Risk Aversion and Expected Utility

    • Rational decision-makers are sometimes willing to prioritize reducing risk over maximizing the expected monetary value (EMV), especially when large sums of money are involved
    • People who prefer avoiding risk are considered risk-averse
    • According to research, decision-makers tend to maximize expected utility, meaning they favor choices that maximize their personal preference for outcomes rather than just maximizing the EMV

    Utility Functions

    • A utility function converts monetary values (payoffs and costs) into utility values
    • It describes individual preferences for monetary outcomes and reflects their attitude towards risk
    • Risk-averse individuals are willing to trade some EMV to avoid risky situations

    Exponential Utility

    • Exponential utility functions have a single adjustable parameter: risk tolerance
    • Risk tolerance dictates how risk-averse an individual is, with higher values indicating less risk aversion
    • The exponential utility function formula is a simplified approach to quantify risk attitude

    Example 6.5: Using Exponential Utility

    • Venture Limited must choose between risky ventures and a safe investment
    • The company's risk tolerance influences its decision, as determined by the exponential utility function
    • By considering the utility values associated with each venture, a better-informed decision can be made

    Example: Investment Projects

    • Investment projects A and B have different expected monetary values (EMV) but generate different utilities based on risk preferences
    • The utility function assigns a utility value to each possible monetary outcome, reflecting the decision-maker's attitude toward risk
    • Choosing the option with the higher utility value for a given risk tolerance maximizes the individual's expected utility

    Is Expected Utility Maximization Used?

    • Maximizing expected utility is a complex process, and its theoretical research value might outweigh its practical application
    • Expected utility maximization is not widely used in business decision analysis
    • In practice, EMV is considered sufficient for most decision-making scenarios and is used more frequently than expected utility maximization

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Related Documents

    Decision Making Under Uncertainty PDF

    Description

    This quiz covers key concepts in sensitivity analysis and decision trees, essential tools for effective decision-making. You'll explore how changes in input variables affect outputs and learn about visualizing decision problems. Test your knowledge on risk profiles and their applications in decision models.

    More Like This

    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser