QUESTION 3 A manager must decide how many machines of a certain type to buy. The

Question

QUESTION 3 A manager must decide how many machines of a certain type to buy. The machines will be used to manufacture a new gear for which there is increased demand. The manager has narrowed the decision to two alternatives: buy one machine or buy two. If only one machine is purchased and demand is more than it carn handle, a second machine can be purchased at a later time. However, the cost per machine would be lower if the two machines were purchased at the same time. The estimated probability of low demand is .30, and the estimated probability of high demand is .70. The net present value associated with the purchase of two machines initially is S76,100 if demand is low and S132,400 if demand is high. The net present value for one machine and low demand is $97,000. If demand is high, there are three options. One option is to do nothing which would have a net present value of $117,850. A second option is to subcontract; that would have a net present value of $115,650. The third option is to purchase a second machine. This option would have a net present value of S113,950 a. What is the EMV (expected monetary value) for alternative buy one machine? The EMV is S b. What is the EMV (expected monetary value) for alternative buy two machines? The EMV is S c. How many machines should the manager purchase initially? The manager should purchase machine(s) initially

Explanation / Answer

EMV= EV

A.

B.

C.

2 machines, as EMV = EV is higher in that

P Situations Formula P*Situation (EV1+EV2) Prob Demand Machines 1 EV1 Tot EV 0.3 Low 97000 29100 111595 Do nothing EV2 0.7 High 117850 82495 Best option Subcontract EV3 115650 80955 Buy Machine EV4 113950 79765 (EV5+EV6) Prob Demand Machines 2 EV5 Tot EV 0.3 Low 76100 22830 115510 Machines 2 EV6 0.7 High 132400 92680

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