Railways is bidding on a project that it figures will cost $300,000 to perform.

Question

Railways is bidding on a project that it figures will cost $300,000 to perform. Using a 25% markup. It will charge $375,000, netting a profit of $75,000. However, it has been learned that another company, bidding on the project. If does submit a bid, it will be a bid of $300,000 Railways really wants this project and is considering a bid with only a 15% markup to $345,000 to ensure submits a bid. (a) Prepare a profit payoff table from Railways point of view. (b) What decision would be made if Railways used the optimistic approach? (c) If is known to submit bids on only 30% of the projects it considers, what decision should Railways make? (d) Given the information in (c), how much would a corporate spy be worth to Railways to find out if will bid?

Explanation / Answer

(a)

The profit payoff table is

If the Railways bid for 25% markup and Transrail bids, Railways does not get the project and the profit of railway is $0.

If the Railways bid for 25% markup and Transrail does not bid, Railways get the project and the profit of railway is $75,000.

If the Railways bid for 15% markup and Transrail bid or does not bid, Railways get the project and the profit of railway is $45,000.

(b)

The maximum payoff for 25% markup is $75,000

The maximum payoff for 15% markup is $45,000

The maximum of these two is $75,000. So, using optimistic approach, the decision of railways is to bid with 25% markup.

(c)

The probability that Transrail submit the bid = 0.3

Then, the probability that Transrail does not submit the bid = 1 - 0.3 = 0.7

Expected payoff for 25% markup = 0.3 * $0 + 0.7 * $75,000 = $52,500

Expected payoff for 15% markup = 0.3 * $45,000 + 0.7 * $45,000 = $45,000

So, the maximum expected payoff is for 25% markup. So, the decision of railways is to bid with 25% markup with expected payoff = $52,500

(d)

If the railways comes to know the decision of Transrail bid by a corporate spy, then the railways will bid with 25% markup , when the transrail does not bid and with 15% markup, when the transrail does bid.

Therefore, the expected payoff of Railways is

Expected payoff = 0.3 * $45,000 + 0.7 * $75,000 = $66,000

So, the maximum railways can pay to corporate spy to get the information =  $66,000 - $52,500 = $13,500

Decision Transrail does bid Transrail doesn't bid 25% markup $0 $75,000 15% markup $45,000 $45,000

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