EXPECTED VALUE AND UNCERTANTY Problem 1: Expected Value Determine whether you wo

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EXPECTED VALUE AND UNCERTANTY Problem 1: Expected Value Determine whether you would decide, based on profitability, to go with the product cluster of Product A, Product B, and Product C or the product cluster of Product X, Product Y, and Product Z. Product cluster ABC has a fixed cost of 8.7% of revenue. Product cluster XYZ has a fixed cost of 9.3% of revenue. Product A is expecting revenues of $900,000 and variable costs of $300,000. Product B is expecting revenues of $700,000 and variable costs of $200,000. Product C is expecting revenues of $800,000 and variable costs of $400,000. The probability of achieving these revenues and costs are 5% for Product A and 25% for Product C? Product X is expecting revenues of $700,000 and variable costs of $300,000. Product Y is expecting revenues of $800,000 and variable costs of $250,000. Product Z is expecting revenues of S600,000 and variable costs of $300,000. The probability of achieving these revenues and costs are 35% for Product X and i596 for Product Z? Your goal is to maximize profits. Which product cluster would you choose? For any credit, you must show all your work. ANSWER:

Explanation / Answer

Expected profit for product cluster ABC = (900000*0.05+700000+800000*0.25)*(1-8.7%) - (300000*0.05+200000+400000*0.25)

= $ 547,785

Expected profit for product cluster XYZ = (700000*0.35+800000+600000*0.15)*(1-9.3%) - (300000*0.35+250000+300000*0.15)

= $ 629,445

It is evident from the calculations above that product cluster XYZ yields higher expected profit.

Therefore, we would choose product cluster XYZ.

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