A local retail store must place orders for Christmas in advance. Assume that eac

Question

A local retail store must place orders for Christmas in advance. Assume that each ornament costs the chain $4. Furthermore, assume that each ornament can be sold for a retail price of $10. If the ornaments are still on the shelves after Christmas, they cannot be sold. The probability distribution of consumer demand for these ornaments (in hundreds) during the upcoming Christmas season has been assessed by the market research specialists and is presented below. Finally, assume that the chain must purchase the ornaments in lots of 100 units.

Demand (in hundreds)

Probability

4

0.20

5

0.70

6

0.10

What is the optimal strategy for order quantity?

Demand (in hundreds)

Probability

4

0.20

5

0.70

6

0.10

Explanation / Answer

Expected demand of chains (in hundreds)= 4x0.2+5x0.7+6x0.1 = 4.9

Assume that 400 chains are ordered, expected profit = 400x(10-4) = $2400

Assume that 500 chains are ordered, expected profit = 490x10-500x4 = $2900

So, the optimal stratedy is to order 500 units

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