A manager is trying to decide whether to build a small, medium, or large facilit

Question

A manager is trying to decide whether to build a small, medium, or large facility. Demand can be low, average, or high, with the estimated probabilities being 0.25, 0.40, and 0.35, respectively. A small facility is expected to ean an after-tax net present value of just $29,000 if demand is low If demand is average, the small facility is expected to eam $45,000; it can be increased to medium size to eam a net present value of $60,000. If demand is high, the small facility is expected to eam $50,000 and can be expanded to medium size to eam $60,000 or to large size to earn $125,000. A medium-sized facility is expected to lose an estimated S25,000 if demand is low and earn $110,000 if demand is average. If demand is high, the medium-sized facility is expected to eam a net present value of $125,000; it can be expanded to a large size for a net payoff of S135,000. If a large facility is built and demand is high, earnings are expected to be $150,000. If demand is average for the large facility, the present value is expected to be $80,000; if demand is low, the facility is expected to lose $80,000. Which alternative is best according to each of the following decision critrion? (Enter your responses as whole numbers.) Decision Value of Return a. Maximin b. Maximax c. Minimax regret thousand thousand thousand

Explanation / Answer

Large facility

At point 1, Payoff = 0.25*160+0.35*80-0.4*80 = 44000 $

Medium facility

At point 2, Payoff = 115 $ when expanded to large facility

At point 1, Payoff = 0.25*115+0.35*90-0.4*75 = 30250 $

Small facility

At point 3, Payoff = 155 $ when expanded to large facility

At point 4, Payoff = 30 $ when expanded to medium facility

At point 1, Payoff = 0.25*155+0.35*30+0.4*24 = 58850 $

Hence, the management should build a small facility in order to achieve the highest expected payoff of 58850 $

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