You are evaluating the development of an information system (IS) to forecast sal

Question

You are evaluating the development of an information system (IS) to forecast sales volumes. You will decide the staffing of a manufacturing line on the basis of this forecasted volume The system may forecast sales as increasing, stable, or decreasing. You respond with either single-shift or double-shift staff levels. Bach of the six possible combinations provides an estimated dollar payoff. If an IS is used, it provides a sales volume forecast (prediction), then the manager chooses a staff level (strategy), and finally an actual sales level (state of nature) occurs, yielding its associated payoff States of nature are uncontrollable but occur with a probability that can be estimated, sometimes from historical data In our example sales historically increased 30% of the time, were stable 45% of the lime, and decreased 25% of the time. Next, the manager must estimate the accuracy of the IS in forecasting sales levels If the IS is infallible, it is called a perfect information system. Most ISs imperfect, and the conditional probabilities in the following table reflect this fact The value 65% in die northwest comer means that w hen sales actually increase in the future period, the IS will have predicted the increase 65% of the time. Note that the sum of any column must equal 100%. Is it worth using the IS system? What is the expected value of perfect information without the IS? What is the expected value of perfect information with the IS? What is the value of the sample information?

Explanation / Answer

Expected value of perfect information without IS

Here we use historical probabilities in determing the expected value

Hence

= 0.3* (11000+18000) + 0..45*(10000+8000)+ 0.25*(2000-3000)

= 0.3*29000+0.45*18000-0.25*1000

= 16550

Expected value using IS

when sales are in increase

= ( 0.65 * 29000 + 0.2 * 18000 - 0.15 * 1000) = 22300

when sales are stable

= (0.1*29000+0.8*18000-0.1*1000) = 17200

when sales are decreasing

= (0.1*29000+0.15*18000-0.75*1000) = 4850

Now, expected value using IS system = 22300 * 0.3 + 17200 * 0.45 + 0.25 * 4850 = 15643

So, net profit for system without IS is favarouble

Extra cost = 16550 - 15463

= $ 1087

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