Vincent Cuomo is the credit manager for the Fine Fabrics Mill. He is currently faced with the
Vincent Cuomo is the credit manager for the Fine Fabrics Mill. He is currently faced with the question of whether to extend $100,000 of credit to a potential new customer, a dress manufacturer. Vincent has three categories for the creditworthiness of a company-poor risk, average risk, and good risk-but he does not know which category fits this potential customer.
Experience indicates that 20 percent of companies similar to this dress manufacturer are poor risks, 50 percent are average risks, and 30 percent are good risks. If credit is extended, the expected profit for poor risks is - $15,000, for average risks $10,000, and for good risks $20,000. If credit is not extended, the dress manufacturer will turn to another mill. Vincent is able to consult a credit-rating organization for a fee of $5,000 per company evaluated. For companies whose actual credit records with the mill turn out to fall into each of the three categories, the following table shows the percentages that were given each of the three possible credit evaluations by the credit-rating organization.
a. Develop a decision analysis formulation of this problem by identifying the decision alternatives, the states of nature, and the payoff table when the credit-rating organization is not used.
b. Assuming the credit-rating organization is not used, use Bayes' decision rule to determine which decision alternative should be chosen.
c. Find the expected value of perfect information.
Does this answer indicate that consideration should be given to using the credit-rating organization?
d. Assume now that the credit-rating organization is used. Develop a probability tree diagram to find the posterior probabilities of the respective states of nature for each of the three possible credit evaluations of this potential customer.
e. Use the corresponding Excel template to obtain the answers for part d.
f. Draw the decision tree for this entire problem by hand. Use this decision tree to determine Vincent's optimal policy.
g. Use RSPE to construct and solve this decision tree.
h. Find the expected value of sample information. If the fee for using the credit-rating organization is open to negotiation, how large can the fee be and use of this organization still be worthwhile?
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