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1. This exam is a take-home exam. You may use the reference material listed in the course guide as well as any work that you have done during the quarter. Please do not refer to any work done by students of previous years. This is meant to be an individual effort; you should not discuss this exam with anyone except the teaching team. We encourage you to use a calculator or a spreadsheet program where needed. 2. Read over each question carefully. You may not need all the information given in a particular problem. 3. On the title page, please write out your full name under the Honor Code. Your exam will not be graded unless you have typed your full name and the Honor Code on the title page. Please submit your final exam solutions via Coursework. Note: If you plan to submit two separate files (e.g. one .doc and one .ppt) then please make sure that you paste the signed honor code on the first page of both documents. 4. Unless stated otherwise, the characters in the exam prefer more money to less and follow the Five Rules of Actional Thought. Do not make any additional assumptions. 5. Please include a general table of contents for the work that you turn in. 6. If you have any questions, please post them to the Coursework Discussion page. Only if you feel that your question will reveal a substantive part of the solution should you email a TA. 7. Clearly show your work. You will not receive credit for illegible work or if you do not show your work. Partial credit will be given where appropriate. For problems with numerical answers, please draw a box around, or otherwise highlight the final answer. 8. The exam is worth a total of 300 points. The points are broken down by question.
In recognition and in the spirit of the Honor Code, I certify that I will neither receive nor give unpermitted aid on this exam and that I will report, to the best of my ability, all Honor Code violations observed.
Name (printed): _______________________________________________
8 6 Certain Equivalent ($K) 4 2 0 -2 0 -4 -6 -8 -10 -12 Bill G.'s Bid Amount ($K) 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40
Please answer the following questions, providing a one or two sentence explanation for each one. (For full credit, numerical answers should be within $1000 of actual values.)
a) [5 points] What is Bill G.s optimal bid? b) [5 points] What is the minimum that Bill G. must bid to be virtually certain that he will acquire the painting? c) [5 points] For reasons known only to him, Warren B. wants to keep Bill G. from participating in this auction. He is willing to pay him not to participate. What is the minimum payment that Bill G. would accept to refrain from participating in the auction? d) [5 points] Warren B. decides not to make the payment discussed in (c), and Bill G. acquires the painting in the auction. Now Warren B. wants to buy the painting from Bill G. What is the minimum payment that Bill G. would accept to sell the painting?
a) [15 points] In this part, assume that there are N people bidding against you in this first-pricesealed auction. Each of them will place a bid distributed according to a Beta distribution with parameters r = 6, n = 12 on the range $0-$100 (i.e. the distribution has a mean of $50). You believe that all N bids are irrelevant to one another given &. For N = 1, N = 2, and N = 3, compute: The optimal bid amount; Certain Equivalent given the optimal bid; The probability of acquiring the certificate at the optimal bid amount. Conclude what do you think will happen as N increases? How would you explain this?
b) [15 points] In this part, assume that there is only one person bidding against you. This person will place a bid distributed according to a Beta distribution with parameters r, n = 2r on the range $0-$100 (i.e. the distribution has a mean of r/n). For r = 1, r = 6, and r = 20, compute: The optimal bid amount; Certain Equivalent given the optimal bid; The probability of acquiring the certificate at the optimal bid amount. Conclude what do you think will happen as r increases? How would you interpret this result, and how would you explain it?
Unit Cost of $23 0.2 Stable Oil Price Market Share at 20% 0.6 0.5 0.6 Unit Cost of $20
Unit Cost of $23 Market Share at 10% 0.25 Unit Cost of $20 0.2 0.8
Unit Cost of $23 0.7 Increase in Oil Price 0.4 Market Share at 20% 0.5 Unit Cost of $20 0.2
Unit Cost of $23 Market Share at 10% 0.25 Unit Cost of $20 0.1 0.9
each unit sold and train the users to fix beta failures. The training would be offered to UDCs engineers in the first year (2011). The parts and servicing equipment per machine sold would be bought by UDC in 2011 as well, and would cost $9,000 per unit sold (in 2011 only and paid by LIM). If the service contract is signed, LIM will pay IPX $750,000 or 23% of the sales price for every ROE-2 sold in UDC during the next year, whichever is greater. This one-time payment would occur in 2011. Of course, LIM could also decide not to sell ROE-2s to UDC. Since this would adversely impact the sales of LIMs other products, LIM considers the loss associated with this alternative to be $8,000 (expressed in 2011 dollars). LIM's experts have given the following rough assessments of the six primary uncertainties:
Description Repair cost uncertainties Avr repair cost, alpha failure Avr repair cost, beta failure Alpha failures per year Beta failures per year Revenue uncertainties Number of machines sold Training costs uncertainties Training cost per machine Low Base High
units
25
30
50
$ thousand
4.0
8.0
12.0
The end of this handout shows the detailed assessments of these uncertainties which LIMs experts would give you if asked. We will not take tax into account for this case study.
3) Your Task:
You are to prepare a Powerpoint presentation aimed at a reader who is well-versed in Decision Analysis, showing your work through one iteration of the Decision Analysis cycle for LIMs decision problem. Your report should comprise the following: A table of contents / agenda in which you will identify key parts of your analysis; Presentation slides showing the insights you gathered from the use of the Decision Analysis tools. Please place each concept or tool on a separate slide, and structure your report in the order shown on the Decision Analysis Cycle (Formulation Evaluation Appraisal). Please do not use more than 20 slides; if your report exceeds this limit you will be penalized for doing so (the 20 slides limit does not include the title page or the table of content). You may include a few more slides beyond the 20-slide limit as an appendix, especially slides showing your trees and calculations in a more detailed manner, but please be aware that they may only influence your grade if we wish to award partial credit for an analysis in which you made a mistake. Please make sure that all the necessary inputs of your model (e.g. the discretized distribution of key uncertainties) are neatly organized in your appendix so that we can easily crosscheck your numbers. Please try to include some slides in the appendix to back up your results as well (e.g. probabilistic dominance analysis). Last, here are some important remarks that we hope will guide you in your analysis: Rely on Tornado Diagrams Six uncertainties is already a respectable amount of complexity, and we do not want you to draw a tree with 729 branches. Instead, use tornado diagrams to identify, for each alternative, the uncertainties which cover 95% of the variance or more. Once you have identified the critical uncertainties, you are allowed to reassess their low base high values using the distributions we are providing. Please discretize those distributions using the equal areas method or the equal areas shortcut method, and show on one of your slides (within the appendix) the end results of those discretizations. You can then use those critical uncertainties to build a probabilistic tree which will help you plot the CDF of each alternative. This CDFs plot should have a step shape since its based on the discretized distributions. There is no need to smooth out this CDFs plot by interpolation. Please note that for each alternative, some of the critical uncertainties might not need to appear in your tree at all, because they do not affect that particular alternative. Insist on your Insights Build a model to translate the problem statement into math. Then do the analysis. Then translate the numbers back into English and burn the math Each time you present a Decision Analysis tool, insist on the insights you are able to derive from it never show analysis just for the sake of analysis.
Appraisal is Essential During the Appraisal phase you should state on which part of the analysis you would focus next. How would you modify your model? What information would you recommend LIM gather? Which assumptions would you question? What new ideas and alternatives would you suggest and explore? Etc.
$9.0
$10.0
$11.0 $ thousand
$12.0
$13.0
$14.0
$6.50
$7.00
$7.50
$8.00
$8.50 $ thousand
$9.00
$9.50
$10.00
$10.50
$11.00
10.0%
12.0%
14.0%
16.0%
18.0%
20.0%
22.0%
Fraction of machines
60.0%
65.0%
70.0%
75.0%
80.0%
85.0%
90.0%
Fraction of machines