Problem 1:

Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:

                              FAVORABLE                                     UNFAVORABLE

                                MARKET                                            MARKET

EQUIPMENT                      ($)                                                        ($)

Sub 100                       300,000                                               -200,000

Oiler J                          250,000                                               -100,000

Texan                           75,000                                                 -18,000

For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.

(a) What type of decision is Ken facing?

(b) What decision criterion should he use?

(c) What alternative is best?

Problem 2:

The Lubricant is an expensive oil newsletter to which many oil giants subscribe, including Ken Brown (see Problem 3-17 for details). In the last issue, the letter described how the demand for oil products would be extremely high. Apparently, the American consumer will continue to use oil products even if the price of these products doubles. Indeed, one of the articles in the Lubricant states that the chances of a favorable market for oil products was 70%, while the chance of an unfavorable market was only 30%. Ken would like to use these probabilities in determining the best decision.

(a) What decision model should be used?

(b) What is the optimal decision?

Problem 3:

Allen Young has always been proud of his personal investment strategies and has done very well over the past several years. He invests primarily in the stock market. Over the past several months, however, Allen has become very concerned about the stock market as a good investment. In some cases it would have been better for Allen to have his money in a bank than in the market. During the next year,

Allen must decide whether to invest $10,000 in the stock market or in a certificate of deposit (CD) at an interest rate of 9%. If the market is good, Allen believes that he could get a 14% return on his money. With a fair market, he expects to get an 8% return. If the market is bad, he will most likely get no return at all-in other words, the return would be 0%. Allen estimates that the probability of a good market is 0.4, the probability of a fair market is 0.4, and the probability of a bad market is 0.2, and he wishes to maximize his long-run average return.

(a) Develop a decision table for this problem.

(b) What is the best decision?

Use Excel's regression option to perform the regression.

Use an Excel spreadsheet file for the calculations and explanations, with one worksheet per problem. Use the problem number for each worksheet name. Cells should contain the formulas (i.e., if a formula was used to calculate the entry in that cell).