Question

Myrtle Air Express decided to offer direct servide from Cleveland to Myrtle Beach. Management must decide between a full-price service using the company's new fleet of jet aircraft and a discount service using smaller-capacity commuter planes. It is clear that the best choice depends on the market reaction to the service Myrtle Air offers.

Management developed estimates of the contribution to profit for each type of service based on three possible levels of demand for service to Myrtle Beach: strong, medium and weak.

The following table shows the estimated quarterly profits (in thousands of dollars):

Service	Strong	Medium	Weak
Full Price	970	720	-400
Discount	530	405	295

Suppose that management of Myrtle Air Express believes that the probabilities are 0.5 for strong, 0.2 for medium, and 0.3 for weak demand. Use the expected value approach to determine the optimal decision.

What is the expected value of the optimal choice? (Round to the nearest whole number. For example, if your answer is 3.11, enter 3.)

Answer 1

To determine the optimal decision from the view point of Myrtle Air Express, the expected value approach is the best case scenario as the profits under the 3 scenarios would be obtained by multiplying the expected quarterly profits with its respective probabilities

So, Under Full Price Service expected value would be; Strong Profits * Strong Probability + Medium Profit * Medium Probability + Weak Profit * Weak Probability

So, Expected Value under Full Price Service = $970*0.5 + $720*0.2 – $400*0.3 = $509

Under Discount Service expected value would be; Strong Profits * Strong Probability + Medium Profit * Medium Probability + Weak Profit * Weak Probability

So, Expected Value under Discount Service = $530*0.5 + $405* 0.2 + $295* 0.3 = $435

So the optimal value is generated by the Full Price service and it’s expected value is $509.