MBA 201A'1a,2a Section 1

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MBA 201A.1a,2aSection 1

• Dylan Minor

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Overview

• Introduction
• Syllabus
• Section Agenda
• (Briefly) Review Class Concepts
• Practice Problem (for decision trees, info value,
  option value, and risk averseness)
• PS1 3
• Answer Questions

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Power Introduction
Name, What you Did, and WHY an MBA?
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Syllabus

• Objective teach the how to and to learn by doing
• Office Hours Tuesday 1130-130 _at_ F589, Please
  come by!
• Attendance Policy
• Communication Policy email, website, and section
  topics
• Final Point
• http//faculty.haas.berkeley.edu/dminor
• dminor_at_haas.berkeley.edu

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Class Concepts Setting up Decision Trees

• Node Types
• Chance Node
• Decision Node
• Terminal Node
• Setting up a Decision Tree
• Timeline
• What has happened already? ? Sunk Costs ignore
  but record? Expected value vs. sunk decision- but
  equivalence with sunk cost
• Is a given node a decision, chance, or terminal
  node?
• How many branches from the node? Are you sure?
  Continue until every branch has come to a dead
  end (i.e., a terminal node)

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Class Concepts Solving Decision Trees

• Backward Induction
• Start from each terminal node and work towards
  the beginning
• Decision Nodes
• Choose the best of the options (and mark it!)
• Chance Nodes
• Find the expected value of the outcomes
• Finally, calculate the EV of the entire tree
  each POSSIBLE terminal node X probability of each
  POSSIBLE terminal node (note all probabilities
  added together better equal 100 and generally
  NOT all terminal nodes are possible)

EV 50.4 -100.6 EV 2 6 EV -4
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Example of Decision Making under Uncertainty
Lets examine an important decision youll make
as an MBA student. You have a friend in town
that you really want to impress by taking them
out to a good dinner. The only problem is youre
not sure if one restaurant- an Italian
restaurant- is still open. However, the other
restaurant, a sushi restaurant, is for sure open,
but its fish quality is uncertain on a given
night. Which restaurant should you take him
to? There is a 50/50 chance the Italian
restaurant is open. There is a p chance the
Sushi is good tonight (and 1-p the sushi is bad).
Here are the payoffs, depending on the
situation Steps Make Decision Tree, Convert
Each node to a value, Determine Best Choice
(start with p.5)
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Example 1 Solution

• When is the Sushi restaurant preferred with any
  p?

• 8p-3gt3, which implies we need pgt.75

• With p.5, what is the expected value of this
  decision tree?

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Whats the information value of being able to
call the Italian Restaurant? (assume p.5 and
independence) Whats the information value of
being able to call the Sushi restaurant? Whats
the information value of being able to call both
restaurants? Whats the option value of going to
the Italian restaurant early enough that you can
still go to Sushi if the Italian restaurant is
closed? Remember dont consider cost of option
or information, just the difference in expected
values with and without it
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Whats the information value of being able to
call the Italian Restaurant? EVinfo)-EVno
info(.56.51)-33.5-3.5 Whats the
information value of being able to call the Sushi
restaurant? (.55.53)-31 Whats the
information value of being able to call both
restaurants? (.56.255.250)-31.25 Whats
the option value of going to the Italian
restaurant early enough that you can still go to
Sushi if the Italian restaurant is closed?
EVoption-EVno option(.56.51)-3.5
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Problem 3 from Problem Set 1 Decision Tree part a
Anything missing?
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Problem 3 from Problem Set 1 Decision Tree
b) Probability of Success? .83.512 c) Expected
gross return .5124mm 2,048,000 d)
Expected net return .512(4-1.5).82.2(-1.5).
2.8(-1)..2.8(-.5) 828,000 e)
Yep f) No No (value is 0 if have one step that
fails)
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Problem 3 from Problem Set 1 Decision Tree part f
Anything missing?
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Problem 3 from Problem Set 1 Decision Tree

• g) .2 chance valuable (i.e., if step 3 of
  original fails)
• h) CONDITIONIAL on having the first 2 steps
  succeed, the option value is EVoption-EVno
  option
• .82.5.2(-.5)-.82.5.2-1.5200k
• Firm should pursue both simultaneously (highest
  EV- follow the arrow)
• j) 850k guaranteed (if alternative process
  available at the beginning) vs. 860k if do both
  not until after step 2gtgt if available at the
  beginning, even greater value (EV
  1,166,000 ) Why greater value if available at
  the beginning?
• THUS, do both still
• What if risk averse?

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Questions on anything else?