INTRODUCTION TO DECISION ANALYSIS

[Slide 3]

Decision Analysis

 A method for reducing uncertainty in the decision-making process through data analysis.
(Brandon Foltz, 2012)
 A formalized approach to making optimal choices under conditions of uncertainty. (Muenning,
2017)

Note: Every successful business makes use of relevant data in making a decision. However, as easy as
it may sound, it is important to take note that there are also times of lack or insufficiency of
information, hence the difficulty of making a decision.

Decision Theory - An analytic and systematic approach to the study of decision-making.

Note: Dito iikot yung topics natin, kung pano nagdedecide whenever there is a circumstance of
uncertainty.

[Slide 4]

Decision-making is the process of making choices. It is about identifying the problem, gathering data,
and analyzing options.

Illustration:

Imagine hiring a salesman for a specific field and there are two candidates. One has experience
in that particular field but only has an average performance history. The other doesn’t have
experience in that field but has an outstanding track record in selling other products. This is what
it means to compare an apple with an orange.

What is the difference between good and bad decisions? Good decisions are those that are based on
logic, consider reliable information and alternatives, and have a systematic approach.

Note: Whereas bad decisions, being the opposite of good ones, have no logical basis, do not
consider available information and alternatives, and do not incorporate techniques.

[Slide 5]
  An Alternative is a course of action one can choose.
 State of Nature is an outcome over which the decision maker has no control.
 Payoff is the value of an alternative for every state of nature, it could be profit, cost, distance,
time, etc. These payoffs are Conditional Values.

[Slide 6-13]

6 Steps in Decision-Making

1. Define the problem.

Whether or not to expand Percival Riego’s product line by manufacturing and marketing a new
product.
2. List the possible alternatives.
Jeydon decided that he could either construct a large or small plant or not to construct it at all.
It is important not to omit important alternatives. Although some may seem to be
inappropriate of little value, it might turn out to be the best option.
3. Identify the possible outcomes or states of nature. Jeydon determines that there are only 2
possible outcomes: the new product could be favorable or unfavorable.
It should be noted that a common mistake is to forget some of the possible outcomes.
Optimists may tend to disregard bad outcomes, while pessimists may ignore favorable
ones.
4. List the payoffs.
Express the payoff from each possible alternative and outcome.
The easiest way to present these values is by constructing a decision table, also referred
to as a payoff table)
5. Select a mathematical decision theory model.
6. Apply the model and make your decision.

[Slide 14-17]

Decision-making Environments: Decision-making under

 Certainty, wherein there is an ample amount of information to make a sound decision; the
outcome of a decision is known
 o i.e., there is only one state of nature
 Risk, the outcome is not known, but probabilities are known
o i.e., there is a 50-50 chance that an alternative could succeed or could go sideways
 Uncertainty, wherein the future outcome is somehow impossible to predict (probabilities are not
known; outcome and probability are not known
o i.e., Alternative No. 1 may have a better payoff if the state of nature so allows

In addition, uncertainty is a result of many causes including but not limited to:

 Lack of information
 Abundance of information
 Conflicting nature of pieces of information
 Measurement errors
 Subjective opinions

[Slide 19]

Decision making under uncertainty

It is often possible to assign probabilities to the states of nature to aid the decision maker in selecting the
decision that has the best outcome.

However, in some cases, the decision maker is not able to assign probabilities.

[Slide 20]

Decision Criteria

Note: There are many approaches to decision-making in the case of uncertainty. These help the
decision maker assess his alternatives and evaluate which would be beneficial in different
aspects.

[Slide 20]

Note: Explain lang yung parts ng payoff table.

[Slide 21-45]

DECISION-MAKING UNDER UNCERTAINTY

The outcome of a decision alternative and its probability is not known.

The criteria for decision-making under uncertainty is based on the assumption that payoff is something in
which larger values are better and high values are desirable.

1. Maximax (Optimistic) – The best or maximum payoff for each alternative is considered and the
alternative with the best payoff is selected; the “best of bests”
a. Pick the maximum payoff for each alternative
b. Pick the maximum of those maximums
2. Maximin (Pessimistic) – the worst payoff for each alternative is considered and the alternative
with the best one is selected; “the best of worsts”
a. Pick the minimum payoff for each alternative
b. Pick the maximum of those minimums
3. Criterion of Realism (Hurwicz) – Often called the weighted average or criterion of rationality,
this is a combination of optimistic and pessimistic decisions. The advantage of this approach is it
allows the decision-maker to build in personal feelings about relative optimism and pessimism.
The alternative with the highest weighted average is selected.
a. Calculate the Hurwicz value for each alternative
b. Pick the alternative of the largest Hurwicz value
4. Equally Likely (Laplace) – uses all the payoffs for each alternative. This involves finding the
average payoff for each alternative and selecting the alternative with the best or highest average.
(The assumption is that the probability of occurrence of each state of nature is equally likely)
a. Calculate the average payoff for each alternative
b. The alternative with the highest average is chosen
5. Minimax Regret – is based on opportunity loss or regret (Opportunity loss refers to the
difference between the optimal profit or payoff for a given state of nature and the actual payoff
received for a particular decision for that state of nature; Regret refers to the amount you give up
for not picking the best alternative in a given state of nature).
Regret = Opportunity cost = Opportunity loss
a. Construct a regret table
Pick the highest value for each state of nature
 Compute each regret for each alternative
b. Pick the maximum regret for each row in regret table
c. Pick the minimum of those maximums

DECISION-MAKING UNDER UNCERTAINTY IN THE PHILIPPINE BUSINESS CONTEXT

Just like every other country, uncertainty permeates every aspect of business operations in the Philippines.
This can arise from various sources including but not limited to economic volatility, political instability,
regulatory changes, technological disruptions, and unpredictable market dynamics.

Economic Volatility: The Philippine economy is subject to fluctuations influenced by global economic
trends, domestic policies, and external factors. Fluctuations in currency exchange rates, interest rates,
inflation, and commodity prices can create uncertainty for businesses in terms of pricing strategies,
investment decisions, and overall financial performance.

Political and Regulatory Environment: Political instability and regulatory changes can significantly
impact business operations and investment decisions. Changes in government policies, laws, and
regulations related to taxation, trade, labor, and industry-specific regulations can introduce uncertainty
and affect the long-term viability of business strategies.

Market Dynamics: The Philippine market is characterized by rapid transformations driven by

technological advancements, changing consumer preferences, and competitive pressures. Market
uncertainties manifest in shifting demand patterns, disruptive innovations, and evolving competitive
landscapes. To thrive amidst uncertainty, businesses must embrace innovation, customer-centricity, and
market agility to capitalize on emerging opportunities and mitigate competitive threats.

Infrastructure and Logistics Challenges: Infrastructure deficiencies and logistical bottlenecks pose
operational challenges for businesses across various sectors in the Philippines. Inadequate transportation
networks, port congestion, and energy shortages disrupt supply chains, hinder productivity, and escalate
costs.
DECISION TREES AND REAL OPTIONS IN FINANCIAL DECISION MAKING

A real option is a right, but not the obligation to undertake certain business opportunities or investments.

Real Options are choices a company’s management gives itself the option to make to expand, change,
or curtail projects based on changing economic, technological, or market conditions

It is referred to as “real” because it typically references projects involving a tangible asset (such as
machinery, land, and buildings, as well as inventory), instead of a financial instrument.

Choices that Fall Under Real Options

The choices that corporate managers face that typically fall under real options analysis are under three
categories of project management.

 As to the size of a project

o To expand, contract, or to expand and contract
 As to the lifetime of a project
o To initiate, delay, abandon
 As to project’s operations
o The process flexibility, product mix, operating scale, etc.

Illustration:

The McDonald's Corporation (MCD) has restaurants in more than 100 countries. Let's say the
company's executives are mulling the decision to open additional restaurants in Russia. The
expansion would fall under the category of a real option to expand.