Hudson Corporation is considering three options for managing its data processing

Question

Hudson Corporation is considering three options for managing its data processing operation: continuing with its own staff, hiring an outside vendor to do the managing (referred to as outsourcing), or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows: a. If the demand probabilities are 0.4, 0.25, and 0.35, which decision alternative will minimize the expected cost of the data processing operation? What is the expected annual cost associated with that recommendation? If required, round your answer to the nearest dollar. b. Construct a risk profile for the optimal decision in part (a). What is the probability of the cost exceeding $550,000? If required,

Explanation / Answer

We have that expected value is the sum of product of all probabilities by its random variable ( that is demand here). So based on this definition,

Expected value for own staff = 0.4(625) +0.25( 500)+ 0.35 ( 400 )

= 250+125+140 = 515

Expected value for outside vendor = 0.4(850) +0.25( 650)+ 0.35 ( 350 )

=340+162.5+122.5=625

and expected value for combination = 0.4(600) +0.25( 400)+ 0.35 ( 300 )

=150+100 + 105 = 355

So clearly optimal decision is to hire the combination (This is answer to fill in first box) of both as their expected value is minimum ($355000).(This is answer to fill in second box.

This is answer of part (a).

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So, based on above calculation, risk profile in tabular form is written as :

Cost Probability

600 0.4

400 0.25

300 0.35

Now from the table for combination, it is cleared that the probability of the cost exceeding $550,000 is 0.40 ( for value 600). So answer for last box = 0.40.

This is the answer for part (b)

  

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