Jerry Bildery\'s factory is considering three approaches for meeting an expected
ID: 366755 • Letter: J
Question
Jerry Bildery's factory is considering three approaches for meeting an expected increase in demand. These three approaches are increasing capacity, using overtime, and buying more equipment. Demand will increase either slightly (S), moderately (M), or greatly (G). The profits for each approach under each possible scenario are as follows:
Demand Scenario
Approach
Slight
Increase
Moderate
Increase
Great
Increase
Increase Capacity
$680,000
$680,000
$680,000
Use Overtime
$520,000
$570,000
$1,200,000
Buy Equipment
$630,000
$840,000
$840,000
For example, if Jerry increases the capacity and the demand increases slightly, he will realize a profit of
$680,000.
Since the goal is to maximize, and Jerry is risk-neutral, he decides to use the Equally Likely
decision criterion to make the decision as to which approach to use. According to this criterion, the appropriate decision will be
a) increase capacity
b) use overtime
c) buy equipment
.
The EMV of this decision is $?
(enter your answer as a whole number).
Demand Scenario
Approach
Slight
Increase
Moderate
Increase
Great
Increase
Increase Capacity
$680,000
$680,000
$680,000
Use Overtime
$520,000
$570,000
$1,200,000
Buy Equipment
$630,000
$840,000
$840,000
Explanation / Answer
Maximum Equally Likelihood criterion:
This principle is based on a simple philosophy that if there is uncertainty about various events, then treat them as equally probable to occur, that is, each state of nature or chance event is assigned an equal probability. It is also known as equal probabilities criterion. In this assumption, the expected value (EV) or average payoff for each course of action or strategy is determined and the strategy with the highest mean value is adopted.
Demand Scenario
Approach
Slight
Increase
Moderate
Increase
Great
Increase
Increase Capacity
$680,000
$680,000
$680,000
Use Overtime
$520,000
$570,000
$1,200,000
Buy Equipment
$630,000
$840,000
$840,000
Approach
Average Profit
Increase Capacity
(680,000 + 680,000 + 680,000)/3 = 680,000
Use Overtime
(520,000 + 570,000 + 1,200,000)/3 = 763,333
Buy Equipment
(630,000 + 840,000 + 840,000)/3 = 770,000
The maximum average profit is $770,000 for the alternative of Buying Equipment.
Thus, according to maximum equally likelihood decision criteria alternative, Buy Equipment maximizes the average profit.
ANS: C. Buy equipment
The Expected Monetary Value (EMV) of the decision = $770,000
Demand Scenario
Approach
Slight
Increase
Moderate
Increase
Great
Increase
Increase Capacity
$680,000
$680,000
$680,000
Use Overtime
$520,000
$570,000
$1,200,000
Buy Equipment
$630,000
$840,000
$840,000
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