. .3.9 Zhu Manufacturing is considering the introduction of a ramily of new prod

Question

. .3.9 Zhu Manufacturing is considering the introduction of a ramily of new products. Long-term demand for the product group is somewhat predictable, so the manufacturer must be con- cerned with the risk of choosing a process that is inappropriate. Fa ye Zhu is VP of operations. She can choose among batch man- ufacturing or custom manufacturing, or she can invest in group technology. Faye won't be able to forecast demand accurately until after she makes the process choice. Demand will be classi- fied into four compartments: poor, fair, good, and excellent. The table below indicates the payoffs (profits) associated with each process/demand combination, as well as the probabilities of each long-term demand level: POOR FAIR GOOD EXCELLENT Probability Batch Custom Group .4 .3 .2 -$ 200,000 $1,000,000 $1,200,000 $1,300,000 $ 100,000 $ 300,000 700,000 $ 800,000 technoloqy -$1,000,000-$ 500,000 $ 500,000 $2,000,000 a) Based on expected value, what choice offers the greatest gain? b) What would Faye Zhu be willing to pay for a forecast that would accurately determine the level of demand in the future? Px

Explanation / Answer

Solution

(a) P(Batch) = -200,000(0.1)+1,000,000(0.4)+1,200,000(0.3)+1,300,000(0.2) = 1000,000

P(Custom) = 100000(0.1)+300000(0.4)+700000(0.3)+800000(0.2) = 500,000

P(Group technology) = -1000000(0.1)-500000(0.4)+500000(0.3)+(0.2)2000000 = 250,000

Batch offers the greatest gain

(b) Expected value of perfect information = 100000(0.1)+1000000(0.4)+1200000(0.3)+2000000(0.2) - 1000000

= 170,000

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