Mini Report #2
Qnt. 5040 Fall Term 2014
Dr. Phillip S. Rokicki
Maximum number of points: 5 points
Decision Tree Analysis – The Prescott Hardware Company Case Study
Introduction:
Decision trees are superb tools for helping you to select between several courses of action. They
provide a highly effective structure in which you can lay out options and investigate the possible
outcomes of choosing those options. They also help you to form a balanced picture of the risks
and rewards associated with each possible course of action.
Key Points for Decision Trees
Decision trees provide an effective method of decision making because they:
1. Visibly lay out the problem so that all options can be tested;
2. Allow you to fully analyze possible consequences of making any given decision;
3. Provide a framework to quantify the values of outcomes and the probabilities of
achieving them; and,
4. Help you to make the best decisions on the basis of current information and best guesses.
As with all decision making methods, decision tree analysis should be used in conjunction with
common sense – decision trees are just one important part of your decision making tool kit.
In this case study you will be using the information from below to create a PrecisionTree 1 for the
Prescott Hardware Company. The company is considering a number of options to build their
75 year old company. They need your help to first display the various options open to them, then
to analyze these options and to recommend a course of action. Read the information carefully. It
contains all of the information that you need to create your PrecisionTree. The analysis is, of
course, up to you. But do it completely.
Background:
The Prescott Hardware Company over on 8th street and
Westview Drive has been in operation for 75 years. It has
produced many different types of hardware over those years, but
now is facing a crisis over the amount of less expensive hardware being imported from China
and the Far East. Current company president, Bobby Mills III recently said to the Prescott
Chamber of Commerce annual awards luncheon,
1 Notice that PrecisionTree is one word with the “p” and the “t” capitalized.
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“At our hardware company we are facing almost unsurmountable problems with low cost
‘foreign’ hardware. As all of you know, our company has a long history of producing
only high quality hardware for industry and for the home user. As my grandfather Bobby
Mills senior said, ‘It has to be top of the line before we put our name on any hardware
we sell.’”
Bobby has asked you to help his senior management team figure out the pros and cons of several
options open to them. To do this you will create a PrecisionTree, analyze the tree using the
maximax, maximin, and the other decision-making techniques presented to you during week nine
chat, and help the company decide which way to proceed.
The Issues:
Bobby has listed a number of options open to his company. Read these carefully and then use
this information to create a PrecisionTree.
1. New Production versus Reengineering Current Products
The company sees one of two decisions that need to be made initially. It can invest its
resources in either a new product production of hardware, or to reengineer some or all of
its current hardware lines.
It views the expense for either decision initially at $1 million for either direction, so this
initial decision will be based on the expected monetary value found at the end of either
branch.
2. New Product Production
If the company decides to develop new products it has two
choices, it can embark on a rapid new product production, or it
can, as it has done in the past, develop new products using its thorough new product
production process. Right now it believes with the cash flow problems that it is having;
there is a 60% chance that it would undertake a rapid new product production.
Market Reaction
If the company undertakes a rapid product production model the company estimates that
the market reaction will be:
Good: 15% – with potential profits of $2 million;
Moderately good: 25% – with profits of $500,000; or,
Poor: 60% – with profits of only $100,000.
If the company undertakes its usual thorough new product production, then it estimates
that the market reaction will be:
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Good: 40% – with potential profits of $3 million;
Moderately good: 40% with potential profits of $1.5 million; or,
Poor: 20% with potential profits of only $200,000
3. Reengineer Current Products
The company can reengineer its current hardware products.
It could, for instance, try and strengthen the current product
line or it could partially restructure the current product line. The company believes
initially that it would be a 50/50 chance that either of these could be accepted.
If the company undertakes a strengthen production line model the company estimates that
the market reaction will be:
Good: 30% – with potential profits of $1 million;
Moderately good: 40% – with profits of $500,000; or,
Poor: 30% – with profits of only $100,000.
If the company undertakes its partially restructure the current product model, then it
estimates that the market reaction will be:
Good: 60% – with potential profits of $750,000; or,
Poor: 40% with potential profits of only $50,000.
Calculating The Value of Uncertain Outcome Nodes
Where you are calculating the value of uncertain outcomes (probability nodes on the
diagram), do this by multiplying the value of the outcomes by their probability. The total
for that node of the tree is the total of these values.
For instance, if the probability of an outcome is 35% and the value for that node is
$200,000 then you multiply $200,000 times .35 and the value of this node is: $70,000.
So this is your last case study. One that I hope will provide you with a real world experience in
decision-making.
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