Situation David Chang is the owner of a small electronics company. In six months, a proposal is due for an electronic timing system for the 2016 Olympic.

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Presentation transcript:

Situation David Chang is the owner of a small electronics company. In six months, a proposal is due for an electronic timing system for the 2016 Olympic Games. For several years, Chang’s company has been developing a new microprocessor referred to as the X-32. The X-32 is a breakthrough component that would allow Chang to develop a timing system that would be superior to any product currently on the market. However, progress in R&D has been slow, and Chang is unsure about whether his staff can complete the X-32 microprocessor in time. If they continue the R&D and succeed in developing the X-32, there is an excellent chance that Chang’s company will win the $1 million Olympic contract. If they continue the R&D but do not successfully complete the X-32, there is a small chance they will still be able to win the same contract with an alternative, inferior timing system that is a modification of one already developed. If they do not continue R&D, there is no chance to win the contract. If he continues the project, Chang must invest $200K in R&D expenses. In addition, making a proposal requires developing a prototype timing system at an additional cost of $50K. Finally, if Chang wins the contract, the finished product will cost an additional $150K to produce. 1 © 2013, Charles E. Noon, Ph.D.

Decision Tree: a tool for representing, evaluating, and communicating a decision process. A decision tree is constructed using branches and nodes. Symbols: Square represents a decision node. Circle represents an uncertain event node Triangle represents a terminal node. Structuring the Decision Situation 2 © 2013, Charles E. Noon, Ph.D.

Structuring the Decision Situation Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win 3 © 2013, Charles E. Noon, Ph.D.

Structuring the Decision Situation Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win -200K -50K +850K -50K +850K 4 © 2013, Charles E. Noon, Ph.D.

Structuring the Decision Situation Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win -200K -50K +850K -50K +850K © 2013, Charles E. Noon, Ph.D.

Structuring the Decision Situation Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win -200K -50K +850K -50K +850K +600K -200K0 -250K +600K -200K -250K © 2013, Charles E. Noon, Ph.D.

Structuring the Decision Situation Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K © 2013, Charles E. Noon, Ph.D.

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K Strategy 1 “Abandon” 8 © 2013, Charles E. Noon, Ph.D. “Abandon” Strategy 1

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K Strategy 2 “Continue ; Make ; Make” 9 © 2013, Charles E. Noon, Ph.D. “Continue; Make: Make” Strategy 2

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K Strategy 3 “Continue ; Make ; Don’t Make” 10 © 2013, Charles E. Noon, Ph.D. “Continue ; Make ; Don’t Make” Strategy 3

Uncertainty in Net Cash Flow $20 $60 $0 or Expected Monetary Value (EMV) = the sum of the payoffs times their probabilities. EMV=$20 EMV=$30 11 © 2013, Charles E. Noon, Ph.D.

Uncertainty in Net Cash Flow EMV =.50(60) -.40(25) +.10(30) = $23K.40 Loss of $25K Gain of $60K Gain of $30K.40 - $25K $60K + $30K 12 © 2013, Charles E. Noon, Ph.D.

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K Evaluating According to EMV 13 © 2013, Charles E. Noon, Ph.D.

Evaluating According to EMV Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K 14 © 2013, Charles E. Noon, Ph.D.

Evaluating According to EMV Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K -200K 515K 15 © 2013, Charles E. Noon, Ph.D.

Evaluating According to EMV Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K -200K 515K 86K 16 © 2013, Charles E. Noon, Ph.D.

Evaluating According to EMV Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K -200K 515K 86K 17 © 2013, Charles E. Noon, Ph.D.

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K -200K 515K 86K Strategy with highest EMV “Continue ; Make ; Don’t Make” 18 © 2013, Charles E. Noon, Ph.D. “Continue; Make; Don’t Make Strategy with highest EMV

Abandon Continue R&D Succeeds R&D Fails Make Proposal Don’t Make Proposal Don’t Make Proposal Make Proposal Lose Win +600K -200K0 -250K +600K -200K -250K K K 515K 81.5K Strategy with 2nd highest EMV 19 © 2013, Charles E. Noon, Ph.D. “Continue ; Make ; Make”