Question

A firm has to decide which one of the three locations is the best to open a new branch. The profitability of each location is affected by the economic conditions and the economic conditions may go up, remain stable or go down with different probabilities. The decision problem faced by the firm is presented in the form of a payoff table as shown below:

		States	of	Nature
		Up (0.5)	Stable (0.3)	Down (0.2)
Decision Alternatives		s 1	s 2	s 3
Location A	d 1	$100,000	$30,000	$0
Location B	d 2	$80,000	$55,000	$25,000
Location C	d 3	$55,000	$55,000	$55,000

  
What is the appropriate decision if a maximin approach is used?

	A.	Choose location C
	B.	Choose either location B or location C
	C.	Choose location A
	D.	Choose location B
	E.	Choose either location A or location C

Answer 1

In maximin approach,

We select the worst case for each decision alternative.

After finding the worst case payoff for each decision alternative, we choose the highest payoff alternative and decision lies on that.

Here,

The worst for d1 is 0

Worst for d2 is $25,000

Worst for d3 is $55,000

Best among these worst is $55,000 for Location C.

Hence Location C should be chosen.

Answer is: (A) Choose Location C.

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