Reference no: EM132263818

1. Morley Properties is planning to build a condominium development on St. Simons Island, Georgia. The company is trying to decide between building a small, medium, or large development. The payoffs received for each size of development will depend on the market demand for condominiums in the area, which could be low, medium, or high. 

The payoff matrix for this decision problem is (payoffs in 1,000s):

Market Demand

Size of 

Development

Low Medium High

Small 400 400 400

Medium 200 500 500

Large -400 300 800

The owner of the company estimates a 21.75% chance that market demand will be low, a 35.5% chance that it will be medium, and a 42.75% chance that it will be high.

a. What decision should be made according to the maximax decision rule?

b. What decision should be made according to the maximin decision rule?

c. What decision should be made according to the minimax regret decision rule?

d. What decision should be made according to the EMV decision rule?

e. What decision should be made according to the EOL decision rule?

2. Refer to question 1. Suppose that the utility function for the owner of Morley Properties can be approximated by the exponential utility function:

U(x) = 1 - e^x/R

The risk tolerance value R = 100 (in $1,000s).

a. Convert the payoff matrix to utility values.

b. What decision provides the owner of the company with the largest expected utility?