Company GSW is considering whether to expand its production. There is uncertaint

Question

Company GSW is considering whether to expand its production. There is uncertainties in regarding to future market conditions for the product, which can be categorized into two states favorable or unfavorable future market. Currently there are three alternatives for the GSW to choose from , in built from a large plant, build a small plant or do nothing. The following table gives the corresponding pay of information in the decision making problems. For example, in GSW build a large plan, if the future market turns out to be favorable for the product, then GSW can made $2,50,000 profits but, if the market turns out to be unfavorable, GSW will lose $2,00,000 If using maximum criterion, what is the best alternative? If the probability that the future market is favorable is equal to 0.5, what is the best strategy? And what is the expected value of the perfect information (ESVI)?

Explanation / Answer

(a) According to Maximin criteria we need to choose the possibility which Maximizes the minimum payoff. the maximum minimum payoff is for when Do nothing strategy which is zero. so the best alternative is to do nothing. (b) if we use laplace criterion Big plant value = 0.5 * 250,000 + 0.5 (-200,0000) = 25,000 small plant value = 0.5 * 125,000 + 0.5 * -25,000 = 50,000 Doing nothing value = 0 So the best strategy will be to build a Small plant (c) for calculating EVPI, we conisder the different choices which maximizes payoff Expected value of information = possiblity of market favourable condition * (maximum payoff) + possiblity of market unfavourable condition * (maximum payoff) Maximum payoff when market is favourable = 250,000 Maximum payoff when market is unfavourable = 0 EVPI = 0.5 * 250000 + 0.5 *0 = $ 125,000

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