ClothTech, Inc., a textile company in North Carolina, is trying to decide whethe
ID: 462672 • Letter: C
Question
ClothTech, Inc., a textile company in North Carolina, is trying to decide whether to expand its factory, sell its factory, or keep things the same. The payoffs for these alternatives depend on whether the economic conditions are good or poor. The decision tree below illustrates the payoffs and probabilities associated with each outcome. Compute the expected money value for each alternative. Which alternative is the best? (Show calculations.) A consulting firm has offered to perform research and forecast the economic conditions for ClothTech. The firm will charge $200, 000 for its services, and it claims that the information will be 100% accurate. Should ClothTech pay for the consulting services? Justify your response with numbers.Explanation / Answer
(a)
Expected money value for Expand option = 0.7*1100000 + 0.3*(-350000)
=$ 665000
Expected money value for Keep the same option = 0.7*600000 + 0.3*(300000)
=$ 510000
Expected money value for Expand option = 0.7*420000 + 0.3*(420000)
=$ 420000
Expected money value for Expand option is highest therefore it is best alternative
(b)
Maximum payoff from the available option when probability is good =$1100000
Maximum payoff from the available option when probability is poor = $420000
Expected value of the decision strategy that uses perfect information from consultant = 0.7*1100000+ 0.3* 420000
= $896000
Expected value of the decision strategy without perfect information from consultant = $665000 (from part (a))
Expected value of perfect information = 896000-665000 =$231000
Cost of perfect information = $ 200000
Additional expected value = 231000- 200000 = $31,000
Therefore, ClothTech should pay for consulting services for additional expected value of $31,000
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