Chapter #5 Solve this one problem Residents of Mill River have fond memories of
ID: 419164 • Letter: C
Question
Chapter #5 Solve this one problem Residents of Mill River have fond memories of ice skating at a local park. An artist has captured the experience in a drawing and is hoping to reproduce it and see framed copes to current and former residents. He thinks that if the market is good he can sell 500 copies of the elegant version at $150 each. If the market is not good, he will sell only 350 at $100 each. He can make a deluxe version of the same drawing instead. He feels that if the market is good he can sell 700 copies of the deluxe version at $100 each. If the market is not good, he will sell only 450 copies at $75 each. In either case, total manufacturing costs will be approximately $30,000. He can also choose to do nothing if he believes there is a 60% probability of a good market, what should he do? Why?Explanation / Answer
Probability (Good Market), p1 = 60% = 0.6
Probability (Not Good Market), p2 = 1 – 0.6 = 0.4
Case 1: Elegant Version
Good Market
Revenue = Units * Selling Price = 500 * $150 = $75,000
Expense = Mfg Cost = $30,000
Net, n1 = Revenue – Expense = $75,000 - $30,000 = $45,000
Not Good Market
Revenue = Units * Selling Price = 350 * $100 = $35,000
Expense = Mfg Cost = $30,000
Net, n2 = Revenue – Expense = $35,000 - $30,000 = $5,000
Expected Monetary Value = p1*n1 + p2*n2
= 0.6*$45,000 + 0.4*$5000
= $29,000
Case 1: Deluxe Version
Good Market
Revenue = Units * Selling Price = 700 * $100 = $70,000
Expense = Mfg Cost = $30,000
Net, n1 = Revenue – Expense = $70,000 - $30,000 = $40,000
Not Good Market
Revenue = Units * Selling Price = 450 * $75 = $33,750
Expense = Mfg Cost = $30,000
Net, n2 = Revenue – Expense = $33,750 - $30,000 = $3,750
Expected Monetary Value = p1*n1 + p2*n2
= 0.6*$40,000 + 0.4*$3750
= $25,500
Since, there is a positive expected monetary value for both the Elegant Version and Deluxe Version so Doing Nothing is rejected. He should go with the one which has greater positive expected monetary value which is Elegant Version with an expected monetary return of $29,000.
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