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 0.40, 0.35, and 0.25, respectively. A small facility is expected to earn an after-tax net present value of just $11,000 if demand is low. If demand is average, the small facility is expected to earn S15,000; it can be increased to medium size to earn a net present value of S30,000. If demand is high, the small facility is expected to eam $50,000 and can be expanded to medium size to earn $60,000 or to large size to earn $100,000 A medium-sized facility is expected to lose an estimated $25,000 if demand is low and earn $100,000 if demand is average. If demand is high, the medium-sized facility is expected to eam a net present value of $150,000, it can be expanded to a large size for a net payoff of $156,000 If a large facility is built and demand is high, eamings are expected to be $160,000. If demand is average for the large facility, the present value is expected to be S80,000; if demand is low, the facility is expected to lose $70,000 Which alternative is best according to each of the following decision criterion? (Enter your responses as whole numbers) Value of Return sthousand Sthousand sthousand a. Maximin Small facility Large facility Medium facility c. Minimax regret regret

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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