Business Analytics and Decision Making
Answer the following questions in paragraph form numbering each one. 2 pages
Question 1a. – One of the biases that has been proposed by Kahneman and Tversky and researched a great deal is the Availability bias. What is the Availability bias? How might it play a role in the following decisions?
Scenario: You are an entrepreneur that has several business investments in real estate, restaurants, and retail stores. You are looking for your next investment opportunity for you and your private equity investment company. You have found two possible alternatives to invest in that will payoff in the next 10 years. Here are the descriptions of the two options.
Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.
High NPV: $5 million, Pr = 0.5
Medium NPV: $2 million, Pr = 0.3
Low NPV: $0, Pr = 0.2
Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.
High NPV: $3 million, Pr = 0.75
Medium NPV: $2 million, Pr = 0.15
Low NPV: $1 million, Pr = 0.1
1b. Consider that the estimated probabilities for both of the High NPV future states are relatively high (0.50 and 0.75). How could the Availability bias be at work here? How could using objective data analysis like frequency distributions mitigate the effect of the Availability bias?
Question 2: Anchoring Bias
What is the Anchoring bias? How might is play a role in the decision in Question 1? In what way might this bias cause error in the estimation of the probabilities? How could you mitigate the effect of this bias?
Question 3: Heuristics
What is the definition of a heuristic decision method? What might be a heuristic method for hiring someone? Explain and justify your logic.
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