Question

Delicious Company needs to know the pounds of apples to have on hand each day. Each pound of apple costs $0.20 and can be sold for $0.60. Unsold apples are worthless at the end of the day. After studying the last six months sales, Delicious Company estimates the future demand to be 300 pounds 35% of the time and 500 pounds 65% of the time.

Required:

Determine whether Delicious Company should order 300 or 500 pounds of apples by

a. Prepare a table showing the operating income of each action choice for each possible order level. (Hint: there are total 4 possible operating incomes)

b. What is the expected operating income of each order option?

Answer 1

Solution:-

(a) Table showing the operating income:-

Quantity ordered	Demand probability	Demand probability	Expected value
	300	500
300	120	120	$120
500	80	200	$158
Probability	35%	65%

Demand probability

300 pounds of apples

(300*0.4) =120 ; (0.4 means = 0.6-0.2)

500 pounds of apples

(300*0.4)-(200*0.2) = 80

(500*0.4) = 200

Expected value

300 pounds of apples = 120*35%+120*65% = 120

500 pounds of apples = 80*35%+200*65% = 158

(b) The expected value is higher in case of 500 pounds of apples, thus FruitCompany should order 500 pounds of apples to maximize profit.