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Final Exam: Large Instrument Manufacturer, Inc.

Final Exam: Large Instrument Manufacturer, Inc. Arunabha Saha. Recommendations. Our intial recommendation to LIM at this point is to pursue the alternative that involves training UDC to handle Beta failures.

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Final Exam: Large Instrument Manufacturer, Inc.

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  1. Final Exam: Large Instrument Manufacturer, Inc. ArunabhaSaha

  2. Recommendations • Our intial recommendation to LIM at this point is to pursue the alternative that involves training UDC to handle Beta failures. • We further recommend a subsequent analysis taking into account much of the information from the first round and assessing the uncertainties.

  3. Outline • Decision Tools Used • Framing • Decision Hierarchy • Decision Diagram • Deterministic Analysis • NPV of Alternatives • Deterministic Sensitivity • Probabilistic Analysis • Decision Tree • Probabilistic Dominance • Appraisal • Sensitivity Analysis • Value of Information and Control • Recommendations for future analysis

  4. Decision Hierarchy • Policy is to be Risk-Neutral in this Range. • Making a profit is the end goal of this exercise. Selling a product but not making a profit is not a desirable option. • ROE-II will be sold only for a period of 5 years hence any strategy should be optimized for the next 5 year period. Policy • To sell ROE-II to UDC or not ? • Eliminate or mitigate the risk associated with servicing that caused the bad experience with ROE-II Strategy • Determine the uncertainties early and how they affect the eventual outcome. • Concentrate on evaluating the important uncertainties before making the decision • Attempt to control the important uncertainties by means at our disposal Tactics

  5. Decision Diagram Units Sold Cost of Beta Failures Num of Beta Failures Training Cost Num of Αlpha Failures Cost of Alpha Failures Total Beta Failure Cost Total Revenue Total Alpha Failure Cost Initial Cost (Training + Installation) Sell ROE-II to UDC Continue with Existing Arrangement Train UDC engineers OR Outsource Value

  6. NPV of Each Strategy at Base Case • We can see that in the base case • “Training UDC” is the best option • Contracting with IPX is also an attractive • Existing option is far worse than either training or contracting

  7. Comparison of Alternatives (100% range) The Key takeaway here is that the “Training UDC” option is the more profitable option in the base case. However the “Train UDC” option also has a higher range (-88, 595) than Contract IPX(0, 347). This “can” imply more risk associated with the “Training WDC” Option

  8. Assessing Important Uncertainties (95%) • From the tornado diagrams above we observe that. • 4 Uncertainties to be assessed for Alternative 1 (Existing arrangement). • 3 Uncertainties for Alternative 2 (Training UDC for servicing) • 1 Uncertainty for Alternative 3 (Contract with IPX) • Alternative 4(Do not Sell) has no uncertainties

  9. Probabilistic AssessmentDiscretizing (Equal Areas – Shortcut) We divided the continuous probabilities into the range {0-25%, 25-75%, 75-100%}. We then arrived at the the values in the table above as the cumulative mean over the individual ranges. We will use these values to further refine our model.

  10. Decision Tree (Condensed) • Alternative 2 (Train UDC) has the best CE and is the initial recommendation if there is no room for further analysis • We do recommend further analysis on uncertainties to assess their impact and devise plans to control them or mitigate their impact

  11. Probabilistic Dominance Profit in $1000s This graph shows the CDF of the Certain Equivalent of 4 alternatives

  12. Dominance Contd..

  13. Value of Information • If LIM is able to get information on “Training Cost” in advance then $28.6K is the highest it should be willing to pay • Similarly $14.31K for information on “Units Sold” and $6.28K for Alpha failures

  14. Value of Control (1 degree) 151.09 148.28 If LIM can control the value of “Units Sold” to 50 units then $151.09K is the most it should be willing to pay, likewise $148.28K for pegging Training Cost to $12.44K

  15. Sensitivity Analysis: Unit Cost

  16. Sensitivity Analysis (Training Cost)

  17. Sensitivity Analysis— Num of Alpha Failures

  18. Sensitivity Analysis— Risk Aversion The decision does not change with change in risk aversion and Train UDCis the best option

  19. Conclusions • Itemsfor a second-round assessment • Determine Value of Information and VoC for multiple degrees e.g(Units Sold & Training Cost) • Identify tools that can effectively provide Control or Information on the uncertainty parameters and evaluate their effectiveness. • Revaluate Risk-Preference • Study ifoptions be used as a tool to mitigate risk ? Instead of Contracting with IPX, buy the option to contract with IPX. • Evaluate an insurance purchase for uncertainties that cannot be controlled.

  20. Appendix Full Decision Tree

  21. Decision Tree (Train WDC Part 1)

  22. Decision Tree: Train WDC Part 2

  23. Decision Tree: Train WDC Part 3

  24. Decision Tree: Contract IPX

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