Assignment # 3

Deadline for submission – 15th June 2020

Q1. Mickey Lawson is considering investing some money that he inherited. The following
payoff table gives the profits that would be realized during the next year for each of three
investment alternatives Mickey is considering (add last four digits of your CMS ID to all
the given “Good Economy” and “Poor Economy” figures/numbers):

a) What decision would maximize expected profits?

b) What is the maximum amount that should be paid for a perfect forecast of the
economy?
c) Develop an opportunity loss table for the investment problem that Mickey Lawson
faces in the problem above. What decision would minimize the expected
opportunity loss? What is the minimum EOL?

Q2. A company is considering the purchase of two types of industrial automated

machines. The first machine (M1) is a large robot capable of performing a variety of tasks,
including welding and painting. The M2 is a smaller and slower machine, but it has all the
capabilities of M1. The robots will be used to perform a variety of repair operations on
large industrial equipment. A “do nothing” alternative is always there, where no purchases
will be made. The market for the repair operation could be either favourable or
unfavourable. If the market is favourable M1 is expected to return $50,000 profit and M2
$30,000 profit. If the market is unfavourable M1 is expected to lead to a loss of $40,000
and M2 to a loss of $20,000 (add last four digits of your CMS ID to all the given “profit”
and “loss” figures/numbers).

a) Construct a payoff matrix showing the three possible alternatives and the
associated profits or losses under the two market conditions.
b) Showing all calculations and the decision tree, what is the optimum decision based
on expected monetary value (EMV), if the probability of a favourable market is 0.6?
What is the expected return on this decision?
c) Assume that the company considers the possibility of conducting a survey to
determine the market potential for industrial equipment repairs using robots. The
cost of the survey is $5,000. Assume that the probability that the survey results are
favorable is 62%. The posterior probabilities are as given in the table below:
 Survey Results Favorable (62%)
Favorable Market Unfavorable Market
Alternative M1/M2
87.1% 12.9%
Survey Results Negative (38%)
Favorable Market Unfavorable Market
Alternative M1/M2
15.8% 84.2%

Showing all calculations and the decision tree, what is the optimum decision based on
expected monetary value (EMV), and what is the expected return on this decision?

d) Using the data for posterior probabilities given above, obtain the following four
conditional probabilities using Bayes’ Theorem:

P(survey positive | Favorable Market)

P(survey positive | Unfavorable Market)
P(survey negative | Favorable Market)
P(survey negative | Unfavorable market)

Q3. Conduct a discounted cash flow calculation to determine the net present value (NPV)
of the following project, assuming a required rate of return (interest value i) of 20%. The
project will cost $75,000 but will result in cash inflows of $20,000, $25,000, $30,000, and
$50,000 in each of the next 4 years (mean values - add last three digits of your CMS ID
to all the given “cost” and “inflow” figures/numbers). The inflows are uncertain but
normally distributed with standard deviations of $1,000, $1,500, $2,000, and $3,500,
respectively. Find the mean forecast NPV using Crystal Ball®. What is the probability the
actual NPV will be positive? Show the output frequency distribution and summary
statistics in your solution. (Use 1000 iterations)

Q4. A 4-year financial project has estimates of net cash flows shown in the following table.
It will cost 65,000 to implement the project, all of which must be invested at the beginning
of the project. After the fourth year, the project will have no residual value (the project will
be scrapped at zero value). Assume that the cash flow estimates for each year are best
represented by a triangular distribution and that the hurdle rate is 20 percent.
 a. Use Crystal Ball® to find the expected NPV of the project (Use 1000 iterations).
b. If an inflation rate of 2 percent, normally distributed with a standard deviation of
.333 percent, is assumed, what is the expected NPV of the project, and what is the
probability that it will qualify (what is the probability of obtaining a positive NPV)? -
(Use 1000 iterations)
Show the output frequency distribution and summary statistics in your solution. Add last
four digits of your CMS ID to all the given “Pessimistic”, “Most Likely” and “Optimistic”
figures/numbers.

Q5. A Company is expanding its operations to include a new drive-in weigh station. The
weigh station will be a heated/air-conditioned building with a large floor and small office.
The large room will have the scales, a 15-foot counter, and several display cases for its
equipment. Before erection of the building, the project manager (PM) evaluated the
project using Activity on Node (AON) analysis. The activities with their corresponding
times were recorded in the table below. Use beta distributions to model the activity
durations and triangular distribution to model the cost rates. Analyze the project for
completion time and total cost using Monte Carlo Simulation (MCS) using 5000 iterations
and answer the following questions:
a) What is the likely total duration of the project (mean, maximum and minimum)?
b) What is the likelihood of completing the project in a time of mean duration plus
minus 3 days?
c) What is the likely total duration of the project corresponding to a 95 percent
certainty?
d) What is the likely total cost of the project (mean, maximum and minimum)?
e) What is the likely total cost of the project corresponding to a 95 percent certainty?
Also add frequency charts and table of summary statistics for both project completion
time and project total cost. Add last two digits of your CMS ID to all the given “Pessimistic”,
“Most Likely / Normal” and “Optimistic” figures/numbers.
Activity Predecessor Activity Durations (Days) Cost Rates ($/Day)
Optimistic Most Pessimistic Optimistic Normal Pessimistic
Likely
1 - 8 10 13 60 70 85
2 - 5 6 8 20 25 35
3 2 13 15 21 40 50 75
4 1, 3 10 12 14 25 30 35
5 4 11 20 30 15 25 30
6 5 4 5 8 20 30 45
7 5 2 3 4 35 40 50
8 7 4 6 10 50 75 100
9 8, 6 2 3 4 15 20 40