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OPIM1012011Spring

ExtraStudyProblemswithSolutions

Q1Q3Mr.Ksisaverypopularhairsalon.Itoffershighqualityhairstylingandphysical
relaxationservicesatareasonableprice,soitalwayshasunlimiteddemand.Theservice
processincludesfiveactivitiesthatareconductedinthesequencedescribedbelow.
(Thetimerequiredforeachactivityisshowninparenthesis):

Activity1:Welcomeaguestandofferhomemadeherbtea.(10minutes)
Activity2:Washandconditionhair.(10minutes)
Activity3:Neck,shoulder,andbackstressreleasemassage.(10minutes)
Activity4:Designthehairstyleanddothehair.(25minutes)
Activity5:Checkouttheguest.(5minutes)

Threeservers(S1,S2,andS3)offertheservicesinaworkerpacedline.Theassignment
oftaskstoserversisthefollowing:
S1doesActivity1.
S2doesActivities2andActivity3.
S3doesActivities4andActivity5.

Q1Whichserveristhebottleneckoftheprocess?

Answer:S1canprocess1/10customersperminute.S2canprocess1/20
customersperminute.S3canprocess1/30customersperminute.S3hasthe
lowestcapacityandishencethebottleneck.

Q2Whatistheutilizationofserver2?

Answer:Sinceweassumethatthereisunlimiteddemand,theflowrateisequal
tothecapacityoftheprocess,i.e.,2customersperhour.
ThecapacityofS2is3customersperhour.
TheutilizationatS2is2/3=66.7%.

Q3Toincreasetheservicerate,Mr.Ksisconsideringtwoalternatives:

AlternativeI:Tohireanewemployeetohelpanyone(andonlyone)oftheservers
withoutchangingthetasksperformedbyeachserver.
AlternativeII:Toredesigntheassignmentoftaskstoservers.Forthis,Mr.Ksis
evaluatingtoreassignActivity5fromS3toS1.

Whatwouldbethecapacityoftheprocessundereachofthetwoalternatives?Assume
thatthesystemoperatesatitscapacity.

Answer:UnderAlternativeI,theadditionalworkerwouldhelpS3andunderthis
casethebottleneckwouldbecomeS2withacapacityof3customers/hr.Under
AlternativeII,S3wouldstillbethebottleneckbutthenewcapacityofS3willbe
of60/25=2.4customers/hr.


Q4Q5ProofSmartInc.,asupplierofhomeinsulationmaterials,wasburneddownina
recentfire.Fromtheremainsofwhatusedtobetheaccountingledger,thefollowing
informationwasrecovered:

2006 2007
Inventory $2,367,121 $2,418,257
GrossMargin 42% 45%
InventoryTurns 11 [unreadable]

Priortothefire,ProofSmartsawasalesgrowthof48%in2007,arecordperformance
forthe18yearoldcompany.(NOTE:Grossmarginisdefinedas1(COGS/Sales).)

Q4.Whatwerethesalesfor2007?

Answer:2006COGS=2,367,121*11=$26,038,331
2006Sales=26,038,331/(142%)=$44,893,674
2007Sales=44,893,674*148%=$66,442,638

Q5.Whatwastheinventoryturnsfor2007?

Answer:2007COGS=66,442,638*(145%)=$36,543,451
2007InventoryTurns=36,543,451/2,418,257=15

Q6Q8LocatedalongsideacobblestonedstreetinOldCity,OldCityPhotographics(OCP)
specializesintheprocessingofthetraditional35mmnegativefilm,aoncedominant
photographicmediumnowindeclineduetothepopularityofdigitalphotography.OCP
offersthreepackagestotheircustomers.Withthestandardpackage,thecustomergets
asetof6x4printsfor$19.99.ThedeluxepackageaddstothestandardpackageaCD
ROMofhighresolutionscansofthepicturesfor$29.99.Finally,the$39.99propackage
issimilartothedeluxepackageinthatitcomeswithaCDROM,althoughthecustomer
getsacontactprintratherthanasetofprints.(Acontactprintisan8x10sheetof
photographicpaperthathasallpicturesontherolloffilmprintednexttoeachotherat
reduceddimensionsandisusedasanindex.)TheworkflowforOCPisshownbelow
(s=standard,d=deluxe,p=pro):


OCPisoperatedbyonepersonateverystation.

Q6.Onaverage,OCPreceive13jobsperhourconsistedof44%standard,37%deluxe
and19%pro.WhichofthefollowingstatementbestdescribesOCPsprocess?

a. Theprocessisdemandconstrained
b. Theprocessiscapacityconstrainedandprocessfilmisthebottleneck
c. Theprocessiscapacityconstrainedandscanfilmisthebottleneck
d. Theprocessiscapacityconstrainedandmake6x4printsisthe
bottleneck
e. Theprocessiscapacityconstrainedandmakecontactprintisthe
bottleneck

Answer:(a)Impliedutilizationis:
(100%*13jobs/hr*2min/job)/(60min/hr)=0.43atprocessfilm
((37%+19%)*13jobs/hr*5min/job)/(60min/hr)=0.61atscanfilm
((44%+37%)*13jobs/hr*4min/job)/(60min/hr)=0.70atmake6x4prints
(19%*13jobs/hr*10min/job)/(60min/hr)=0.41atmakecontactprint
Asimpliedutilizationislessthan1.0atallsteps,theprocessisdemand
constrained.

Q7.Whatistheimpliedutilization(ratioofworkloadrelativetocapacity)atScanFilm

Answer:((37%+19%)*13jobs/hr*5min/job)/(60min/hr)=0.61atscanfilm

Q8.Fixingtherelativeproportionsofjobtypes,whatisthelargestnumberofjobsper
hourthatOCPcanhandle?

Answer:FromthecalculationsforOCP1,weknowthatmake6x4printswill
becomethebottleneckoncetheprocessiscapacityconstrained(ifthemixofjobs
doesnotchange).Theanswertoourpresentquestionisthusgivenbythe
solutionXtotheequation
((44%+37%)*Xjobs/hr*4min/job)/(60min/hr)=1.00.

Rearrangingtheequationyields
X=(60min/hr)/(81%*4min/job)=18.5jobs/hr.

Q9Q10Thefollowingtableshowsfinancialdata(year2006)forDirtCheapWholesale
andKwikiMart,twoUSretailers.

DIRTCHEAP KWIKIMART
WHOLESALE STORES
Inventories($MM) 4754 40894
Sales(net$MM) 59217 397206
COGS($MM) 52762 326606

Assumethatbothcompanieshaveanaverageannualholdingcostrateof20%(i.e.it
costsbothretailers$2toholdanitemthattheyprocuredfor$10foroneentireyear).

Q9Howmanydays,onaverage,doesaproductstayinDirtCheapsinventorybeforeit
issold?Assumethatstoresoperate365daysayear.

Answer:DirtCheaphasaCOGS=$52762M=flowrateR.InventoryI=$4754M.
Therefore,flowtimeT=I/R=4754/52762=.09years,or32.89days.

Q10Howmuchlower(expressedin$s)is,onaverage,theinventorycostforDirtCheap
comparedtoKwikiMartofahouseholdcleanervaluedat$5COGS?Assumethatthe
unitcostofthehouseholdcleaneristhesameforbothcompaniesandthattheprice
andtheinventoryturnsofanitemareindependent.

Answer:InventoryturnsforDirtCheap=1/.09=11.1turns.FlowtimeforKwiki
Mart=Inventory/COGS=40894/326606=0.125.Thereforeinventoryturnsfor
KwikiMart=7.98.Holdingcostsperyear=20%or$1perunitforoneyear.This
meansinventorycostsperunitforDirtCheap=1/11.1=$0.09.ForKwikiMart,
theinventorycostsperunit=1/7.98=$0.125.SoDirtCheapscostsare3.5cents
lower.



Q11Q14ComfyShoesIncbuildsshoestailoredtomeeteachindividualcustomers
needs.CustomerswhovisitthedowntownofficesofComfyShoesinPhiladelphiacan
chooseoneormoreofthefollowingfourcustomtailoringservices.Customersreceive
theirshoesinthemailwithinaweekoftheirinitialvisit.

Service Description Time Resourceused
A.WalkingBasics Takemeasurementsforbasic 12min. 1attendant
walkingshoes.

B.WalkingPlus Choosespecificdesign(e.g. 12min. 1attendant


material,colorselection)

C.RunningBasics Takemeasurementsfortailor 10min. 1attendant


maderunningshoes
D.RunningAdv Consultphysicaltherapistand 40min. 1attendant
obtainpreciseneedsforrunning
shoes.Alsochoosespecific
design.

Thecompanyoffersthefollowingpackagestotheircustomers:

Package1:IncludesonlyWalkingBasics(ServiceA)
Package2:IncludesWalkingBasicsandWalkingPlus(ServicesAandB).
Package3:WalkingBasics,WalkingPlusandRunningBasics(ServicesA,BandC).
Package4:Allfourservices(A,B,C,andD)

CustomersofComfyShoesvisitthestoreataconstantrate(youcanignoreanyeffects
ofvariability)of20customersperday.Ofthesecustomers,45%buyPackage1,10%buy
Package2,20%buyPackage3and25%buyPackage4.Themixdoesnotchangeover
thecourseoftheday.Thestoreoperates12hoursaday.

Q11WhatistheimpliedutilizationoftheattendantinserviceD?

Answer:Thecalculationsaresummarizedbelow:

Package
1 2 3 4 Total Utilization
Task Time(min)#workers Avail.Cap. 0.45 0.10 0.20 0.25
A.WalkingBasics 12 1 60 9 2 4 5 20 0.33
B.WalkingPlus 12 1 60 2 4 5 11 0.183
C.RunningBasics 10 1 72 4 5 9 0.125
D.RunningAdv 40 1 18 5 5 0.278
ServiceDhasanimpliedutilizationof28%

Q12Whichresourcehasthehighestimpliedutilization?

Answer:ServiceA(WalkingBasics)hasthehighestimpliedutilization

Q13Attheendofthespringseason,ComfyShoesanticipatesanincreaseinthedemand
to50customersperday.Achangeinthemixofpackagesdemandedisalsoexpected:
30%ofthecustomersaskforPackage1,10%forPackage2,10%forPackage3and50%
forPackage4.ThecompanywillhireanadditionalattendanttohelpwithServiceA
(WalkingBasics)Whatwillbethebottleneckintheprocessgiventhisnewdemand
pattern?

Answer:Calculationsareasfollows:

Package
1 2 3 4 Total Utilization
Task Time(min)#workers Avail.Cap. 0.3 0.10 0.10 0.5
A.WalkingBasics 12 2 120 15 5 5 25 50 0.417
B.WalkingPlus 12 1 60 5 5 25 35 0.58
C.RunningBasics 10 1 60 5 25 30 0.50
D.RunningAdv 40 1 18 25 25 1.39

ServiceDisthenewbottleneck

Q14Howmanycustomersadaywillnotbeserved?

Answer:ServiceDreceives0.5*(50/12)*40=83.33minutesofworkeveryhour.
Only60minutesofworkcanbeserved.Thus,everyhour,23.33minutesofwork,
or23.33/40customerisnotserved.
Customersnotservedinaday=[(83.33360)/40]*12=7customersadaywill
notbeserved


Q15Q19OneHourLoanofferscustomizedloans.Customerscallatollfreenumber
withaspecificloanrequest,andobtainaresponsewithinanhour.OneHourLoans
businessprocessincludesfiveactivitieswhichmustbeconductedinthesequence
describedbelow.(Thetimerequiredforeachactivityisshowninparenthesis):

Activity1:Answercustomercallandrecordkeyinformation.(4minutes)
Activity2:Gatherandformattheinformation(obtaincreditscores,organizecustomer
specificneeds)foranalysis(5minutes)
Activity3:Analyzetheinformation:Checkthecreditworthiness,anddecideloan
amountandAPRtooffer.(7minutes)
Activity4:Performfinalchecksonloanoffer(2minutes)
Activity5:Callcustomerbackwiththenewloanofferandclose.(4minutes)

Thewholeprocessisconductedbythreeworkersinaworkerpacedline.The
assignmentoftaskstoworkersisthefollowing:
W1doesActivity1.
W2doesActivities2and3.
W3doesActivities4and5.

Q15Whatisthebottleneckoftheprocess?

Answer:W2isthebottleneck:Thecapacitiesare1/4,1/(5+7),and1/(2+4)
respectively.

Q16Howmuchtimewillittaketoprocess100loans?(Assumethattheprocessstarts
withanemptyproductionline)

Answer:Seethefollowingcalculations:
x 1
Time through an empty process
flow rate
100 1
4 5 7 2 4
1
12
1210 minutes

Q17Whatistheutilizationofworker3?(Youcanassumethattheprocessoperatesat
capacityandyoudonothavetoconsideranyemptysystemeffects).

Answer:Seethefollowingcalculations
flow rate
utilization=
capacity

60 / (7 5)
utilization w3 0.5
60 / (2 4)

Q18Toincreasetheproductionrate,OneHourLoanisconsideringtwoalternatives:

AlternativeI:Tohireanewworkertohelpanyone(andonlyone)oftheworkers
withoutchangingthetasksperformedbyeachworker.
AlternativeII:Toredesigntheassignmentoftaskstoworkers.Forthis,thecompanyis
evaluatingtoreassignStep2fromW2toW1.

SupposethatAlternativeIischosen.Whichworkershouldthenewemployeeassist?

Answer:ShouldassistW2becauseheisthebottleneck.

Q19SupposeAlternativeIIischosen.Whatisthenewcapacityoftheprocess?

Answer:Capacitiesoftheworkersare1/(4+5),1/7,1/(2+4),sothenewbottleneck
isW1withacapacityof1/9thcustomersperminute.

Q20Q24NewtPhillyneedstodecidewheretogetahaircut.Hehasnarrowedthe
choicedowntotwolocalhairsalonsLargeHairSalon(LHS)andSmallHairCutters
(SHC).

Duringbusyperiods,anewcustomerwalksintoLHSevery15minutes(withastandard
deviationof15minutes).AtSHC,acustomerwalksineveryhour(withastandard
deviationof1hour).LHShasastaffof4barbers,whileSHChas1barber.Atypical
servicetimeateithersalonlasts30minutes(withastandarddeviationof30minutes).

Q20IfNewtwalksintoLHSduringabusyperiod,howlongmusthewaitinlinebefore
hecanseeabarber?(Onlyincludethewaitingtime,notanyservicetime)

Answer:

activity time
utilization =
interarrival time number of servers
30
= 0.5
15 4
activity time utilization 2(# of servers+1) 1 CVa 2 CVp 2
Tq
# of servers 1 utilization 2
30 0.5 2(4 1) 1 1 1
( )
4 1 0.5 2
3.35 minutes

Q21IfNewtgoestoSHC,howlongmusthewaitinlinebeforehishaircutstarts?

Answer:

30
utilization = 0.5
60 1
30 0.5 22 1
Tq 1
1 1 0.5
30 minutes


Q22AssumethatittakesNewt10minutestoleaveworkandwalktoLHSand10
minutestowalkback(i.e.eachwayofthewalktakes10minutes).Howlongwillhe
needtoleaveworkfortogetahaircutatLHS?

Answer:

Tq Activity time travel time
= 3.35 + 30 + 20
= 53.35 minutes


Q23LHSwillbuyoutSHC.LHSwillthencloseSHCsoperationsandserveallcustomers,
includingexistingSHCcustomers,attheLHSlocationonly.Assumingthattheprevious
trafficofSHCcustomersnowflowstotheLHSlocation,whatisthenewinterarrival
timeatLHS?

Answer:

60 minutes
12 minutes
4 +1 people

Q24Toaccommodatethenewflowrate,LHSnowstaffsoneadditionalbarber(to
increasetheheadcountto5).IsthenewwaitingtimeatLHSlessthanorgreaterthan
thewaitingtimeofLHSbeforethemerger?(Assumethatthecoefficientofvariationof
customerinterarrivaltimesis1).

Answer:
30
utilization = 0.5
12 5
30 0.5 26 1
Tq 1
5 1 0.5
2.17 minute
The new waiting time at LHS is shorter now than before.

Q25Considerthefollowingthreeprocessdesignstoorganizeacallcenterwith12
employees.Thecenterhandlescallsfortwocustomertypes.Type1customerscallwith
creditcardrelatedquestionsandtype2customerscallwithquestionsrelatedtothe
onlineaccountopening.Onabusydaythecallcenterreceives60callsperhourfrom
type1customersand30callsperhourfromtype2customers.Ittakesonaverage2
minutestoservicebothkindsofcalls.

Processdesign1:6employeeshandletype1calls;theother6employeeshandletype2
calls
Processdesign2:8employeeshandletype1calls;4employeestype2calls.
Processdesign3:12persons(crosstrained)handleallcalls.

Whichofthethreeprocessdesignsleadstotheshortest(longest)averagewaitingtime
forarandomincomingrequest?

Answer:3istheshortest,1isthelongest.Design3deployspooling,whichhence
significantlyreduceaveragewaitingtime.Design2allocatesemployees
proportionallyaccordingtothedemandoftype1and2customers.Thisworks
betterthanDesign1whichallocatesresourcesevenly.

Q26Intheautoindustrytheirinventoryisoftendescribedintermsofdaysofsupply,
whichisthenumberofdaysthecurrentinventorywouldlastatthecurrentsalesrate.
Forexample,ifadealerhas20carsandsellsonaverage1careveryotherday(0.5per
day)thenthedealerwouldhavea20/0.5=40daysofsupply.Supposeadealerhas80
daysofsupply.Whatisthedealersannualinventoryturns?Assume365daysperyear.

Answer:Thereare365daysperyear,soan80daysofsupplyrepresentsturnsof
365/80=4.6turnsperyear.

Q27HomeSolutions,ahardwareretailer,isconsideringaddingaLavalamptoits
assortment.GivenitsrentalcostsandthedimensionsofthisLavalamp,itwouldcostHS
$5toholdoneLavaLampforoneyear.Basedonsimilaritems,HSalsoestimatesthatit
wouldneedtoholdabout4.5monthsofsupplyofthislampanditwouldsellabouta
totalof25unitsperyear.IfHSaddsthisitemtotheassortmentandifitsestimatesare
correct,whatwouldbetheholdingcostperlampsold?

Answer:A4.5monthsofsupplymeanstheycarry4.5x(25/12)=9.38unitson
average.Theirtotalspacecostisthus$5x9.38=$46.88.Theysell25units,so
thecostperunitsoldis$46.88/25=$1.88.Thereisanotherwaytothinkabout
this.Theaverageunitspends4.5monthsininventory,whichis4.5/12=0.375
yearsininventory.Thatmeansitincursspacecostatthatrateof0.375x5=
$1.88.

Q28Considertwohomeapplianceretailers,AandB.RetailerAturneditsinventory8.1
timesin2008whereasRetailerBturneditsinventory6.3timesin2008.Interestingly,
their2008saleswerenearlyidentical($15.6b)andtheirendinginventorywasnearly
identical($1.4b).Whichofthefollowingstatementsismostlikelytrueregardingtheir
grossmargin(recall,grossmargin=salesCOGs)?

a) RetailerAhasthehighergrossmarginbecauseithasthehigherinventory
turns.
b) RetailerBhasthehighergrossmarginbecauseithasthelowerinventory
turns.
c) Theyhavethesamegrossmarginbecausetheirsalesareidentical(andit
doesntmatterthattheirinventoryisthesame).
d) Theyhavethesamegrossmarginbecausetheirinventoryisidentical(andit
doesntmatterthantheirsalesarethesame).
e) Theyhavethesamegrossmarginbecausetheirsalesandtheirinventoryare
identical.
f) Thereisnotenoughinformationtodeterminetherelationshipbetweentheir
grossmargins.

Answer(b):Turns=COGs/Inventory.SoCOGS=TurnsxInventory.ForA,COGs=
8.1x1.4=11.34.ForB,COGs=6.3x1.4=8.82.Asgrossmarginisthus15.6
11.34=$4.26bwhereasBsgrossmarginis15.68.82=$6.78b.Hence,Retailer
Bhasthehighergrossmarginandisthus,moreprofitablebecauseithasa
highergrossmarginforthesameinventoryinvestment.

Q29Onaverage500studentsenrollasfreshmaneachyeartoacollege.Onaverage750
studentsgraduatefromthesamecollegeeachyearbecausethecollegealsoaccepts
sophomore,juniorandseniortransfers.Infact,onaverage,atanygiventimethereare
625studentsenrolledinthecollegewhodidnotenrollasfreshman(i.e.,theyare
transferstudents).Onaverage,howlongdoesatransferstudentspendatthecollege?
Assumeallstudentswhoareadmitted(eitherasfreshmanorastransfers)graduate.

Answer:Ifthereare750graduateseachyearand500freshmanenrollments,
thentheremustbe250transferstudentsgraduatingeachyear.Ifthereare625
transferstudents,thenuseLittlesLawtodeterminethenumberofyearsthe
averagetransferstudentspendsatthecollege:625/250=2.5years.

Q30NetDvdisawebbasedDVDrentalservice.(ThinkNetFlix.)Theyofferoneproduct
for$20permonthacustomercanhaveupto4DVDsandessentiallyeverycustomer
alwayshas4DVDsonhisorherlist.Therearenolatefees,socustomerscankeep
moviesaslittleoraslongastheylike(butnomorethan4atatime).ToexchangeDVDs
customersmerelymailbacktheDVDtheynolongerwantandanewoneissentto
them.NetDvdhasdeterminedthattheDVDsspendonaverage18monthsintheir
system(eitherintheirmailcentersorwithcustomers),afterwhichtheyareretired
andremovedfromcirculation.Atanyonegiventime,90%oftheirDVDsareassignedto
customers(i.e.,onsomecustomerslistof4DVDs)while10%areintheirmailcenters
withoutbeingassignedtoacustomer.Theyhaveanaverageof100,000customersat
anyonegiventimeandthatamountisneithershrinkingnorgrowing.HowmanyDVDs
doesNetDVDneedtopurchaseeachmonth?

Answer:100,000customersx4DVDspercustomer=400,000DVDsassignedto
customers.Thisis90%oftheirtotalcollection,sotheirtotalcollectionis
400,000/0.9=444,444DVDs.TheaverageDVDspends18monthsintheir
system,sotheinflowofDVDsis444,444/18=24,691permonth.

Q31TheJournalofCrypticPsychologyfollowsthefollowingprocesstodecidewhatto
print.First,authorssubmittheirpaperstooneofthe40AssociateEditorswhoeither
rejectsthepaperorallowstheauthortorevisetheirpaper.Ifthedecisionis
revisethenanauthorreviseshis/herpaperbasedontheAssociateEditors
comments,andwhenfinished,submitstherevisiontotheEditor.
80%
Reject
Associate 25% Reject
Editor Authors
Editor
revise
20% Revise Accept
75%

TheEditordecidestorejectoracceptthepaperandonlyacceptedpapersare
printedinthejournal.AssociateEditorschooserevisewithonly20%ofpapersthey
seeandtheEditoracceptsonly75%ofthepapersshesees.Theaverageandstandard
deviationofprocessingtimesaregiveninthetablebelow:

Associate Editors Authors Revise Editor


Average processing time (in months) 2 6 0.2
Standard deviation of processing time (in months) 2 10 0.4

Thejournalprintsonaverage30papersperyear.Onaverage,howmanymanuscripts
arecurrentlybeingrevisedbyauthors?

Answer:Thejournalprints30papersperyear,buttheEditoracceptsonly3/4ths
ofthem.SotheEditormustread30x4/3=40papersperyear.Hence,the
authorsmustberevising40papersperyear.UseLittlesLaw,I=RxT,whereR=
40andT=1/2,soI=20papers.

Q32Q34GoldmanSachs(GS)hirescandidateswithstronganalyticalskillsforitsentry
levelanalystposition.Thispositionprovidesastartingsalaryof$70,000/year.They
estimatethat1outof10candidatesisgood.Agoodcandidate(moneymaker)
generates$700,000ayear,whileanotsogoodcandidate(moneyloser)loses
$70,000inthefirstyear.However,GSdoesnotknowwhetheracandidateismoney
makerormoneyloserwhilemakingthehiringdecision.

Q32IfGSistomaximizeitsexpectedprofit,whatisthedecision(hireornothire)?What
istheexpectedprofitofthatdecision?

Answer:ifhire,theexpectedprofitis$700,000*0.1+($70,000)*0.9$70,000=
$63,000.Ifnothire,theexpectedprofitiszero.GSshouldnothire,andthe
expectedprofitiszero.



Q33Whatistheexpectedvalueofperfectinformationinthiscase?

Answer:ifGShasperfectinformationaboutthetypeofacandidate,theywillhire
thecandidateifheisamoneymaker,andnothireifheisamoneyloser.The
expectedprofitis($700,000$70,000)*0.1+0=$63,000.Expectedvalueof
perfectinformationis$63,0000=$63,000.



Q34GSdecidestoofferAptitudeTesttoeachcandidateinordertobetterevaluatethe
chancethatthegivencandidateisapotentialmoneymaker.Historicaldataonsuch
testsshowsthatamoneymakerpassesthetestwith90%probability,andthemoney
loserpasseswith30%probability.Thecostofadministeringsuchtestis$7,000per
person.Whatistheexpectedvalueofthesampleinformationofthetest?ShouldGS
conductsuchtest?

Answer:thejointprobabilityofbeingagoodcandidateandpassingthetestis
0.1*0.9=0.09.Thejointprobabilityofbeingabadcandidateandpassingthetest
is0.9*0.3=0.27.Theprobabilityofpassingthetestis0.09+0.27=0.36.The
probabilityofbeingagoodcandidateconditionalonpassingthetestis
0.09/0.36=0.25.Theprobabilityofbeingabadcandidateconditionalonpassing
thetestis0.75.Theprobabilityofbeingagoodcandidategivenfailingthetestis
0.1*0.1/(0.1*0.1+0.9*0.7)=0.0156.Theprobabilityofbeingabadcandidate
givenfailingthetestis10.0156=0.9844.
Theexpectedvalueofthetestinformationis0.36*52.5+00=18.9thousand
dollars.Thecostofthistest,$7000,islowerthantheexpectedvalue.Thus,GS
shouldconductsuchtest.



Q35Q37Yourethinkingaboutmarketinganewproduct:ChocolateCoatedCrickets
highinprotein,lowinfat.Yourfixedcostsforlargescaleproductionare$10,000,and
youwillincurthesecostsonlyifyoudecidetogoaheadwiththenewproduct.Variable
costsare10cpercricket,andrevenuesare50cpercricket.Youexpectthemarketmay
turnoutoneoftwoways:
1) Good(40%chance),inwhichcaseyoullsell50,000crickets
2) Bad(60%chance),inwhichcaseyoullsell5,000crickets

Q35Whichdecisionalternativewouldyouchooseifyouwanttomaximizetheexpected
profits?
Answer:Weshouldnotlaunchtheproduct,andtheexpectedprofitiszero.See
thefollowingcalculation:




Q36Q38Astartupcompanyisaskingforaninvestment(fromyou)for$50Million.If
thestartupsucceedsandbecomesaprofitablecompanyitwillhaveamarket
capitalizationof$500Million(i.e.thecompanywillbeworth$500Million).Ifthe
companyfailsitwillbeworthnothing.Ingeneral,youassumethat40%ofallstartup
firmsactuallyendupsucceedinginthemarketandtheremaining60%fail.Youownhalf
thestartupcompany(i.e.youget50%ownership)ifyoudecidetoinvestthe$50
Million.

Yourinlawsrunacompanyofferinginvestmentadviceforventurecapitalists.In
particularthisfirmwillgiveyoutheirpredictiononwhetheranystartupfirmwill
succeedornot.Asunpleasantasthisoptionsounds,itmaybeworthconsideringsince
theirpredictionhasthefollowingreliabilities:p(succeed|predictsucceed)=0.7and
p(fail|predictfail)=0.9.Yourinlawswillchargeyou$10millionforthisprediction.

Q36Shouldyouinvestinthisstartupcompanyifyouwanttomaximizetheexpected
profit?
Answer:



Theexpectedgainofinvestingis200*0.4+(50)*0.6=50milliondollars.The
decisionistoinvest.

Q37Whatistheexpectedvalueofperfectinformation?

Answer:Withperfectinformation,theexpectedprofitis200*0.4+0=80million
dollars.TheEVPIis8050=30milliondollars.

Q38Whatistheexpectedvalueoftheprediction?

Answer:supposetheprobabilityofpredictingsuccessisx,thenwehavex*
0.70+(1x)*0.10=0.4.Then,xis0.5.Theexpectedprofitwhenpurchasing
marketpredictionfromyourinlawswillbe125*0.5+0=62.5milliondollars.Then
EVSIis62.550=12.5milliondollars.Then,itisworthpaying$10millionforthe
information.

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