Question

A manager is trying to decide to build a medium or large facility.

A medium-sized facility is expected to earn $140.000 if demand is average. If demand is high, the medium-sized facility is expected to earn $150,000. If the demand is low, there is a $25,000 loss.

If a large facility is built and demand is high, earnings are expected to be $220,000. If demand is average for the large facility, it is expected to earn $125,000. If the demand is low, there is a $60,000 loss.

The probabilities for low, average and high demand are 0.25 for low, 0.40 for average and 0.35 for high demand.

a) Draw the decision tree for this problem.

b) Which size facility should the company build, using an expected value analysis?

Answer 1

Expected value analysis=

For medium size facility

$(-25,000*0.25+140,000*0.40+150,000*0.35

$(-6,250+56,000+52,500)

$102,250

For Large size facility:

$(-60,000*0.25+125,000*0.40+220,000*0.35)

$(-15,000+50,000+77,000)

$112,000

So, company should build large size facility.