70.A small parts manufacturer urer has just engineered a new product for the aut

Question

70.A small parts manufacturer urer has just engineered a new product for the automotive produce the part the company can expand existing facilities, just acquire a competitor, or subcontract production The company believes the probabilities oxperience high market demand or low market demand, with probabilities of 0.6 and 0.4, respectively. The yoff table describes the company's decision situation. States of Nature Decision High Demand Low Demand (0.6) (0.4) Expand Facilities $2,000,000 -1,250,000 Acquire Competitor Subcontract 750,000 -500,000 250,000 25,000 Production The expected value of perfect information for the small parts manufacturer is a. $1,210,000 b. $700,000 c. $510,000 d. $312,500

Explanation / Answer

68.

The expected value of 'Expand facility' decision = 0.6 x $2,000,000 + 0.4 x (-$1,250,000) = $700,000

70.

Similarly,

The expected value of 'Acquire competitor' decision = 0.6 x $750,000 + 0.4 x (-$500,000) = $250,000
The expected value of 'Subcontract production' decision = 0.6 x $250,000 + 0.4 x $25,000 = $160,000

So, max. EMV = max(700000, 250000, 160000) = $700,000

Expected value of perfect information = Expected value with perfect information - max. EMV

Expected value with perfect information = 0.6 x $2,000,000 + 0.4 x $25,000 = $1,210,000

So, Expected value of perfect information = $1,210,000 - $700,000 = $510,000

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