Question

Hudson Corporation is considering three options for managing its data processing operation: continuing with its own staff, hiring an outside vendor to do the managing (referred to as outsourcing), or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows:

	Demand
Staffing Options	High	Medium	Low
Own staff	625	500	400
Outside vendor	850	650	350
Combination	600	400	300

(a)	If the demand probabilities are 0.4, 0.25, and 0.35, which decision alternative will minimize the expected cost of the data processing operation?
	- Select your answer -Own staffOutside vendorCombinationItem 1
	What is the expected annual cost associated with that recommendation?
	Expected annual cost = $
(b)	Construct a risk profile for the optimal decision in part (a).
	The input in the box below will not be graded, but may be reviewed and considered by your instructor.
	What is the probability of the cost exceeding $550,000 ?
	If required, round your answer to two decimal places.
	Probability =

Answer 1

(a)

Expected cost for an alternative is determining by adding the product of payoff and probability under various demand states for a given alternative.

Expected cost of Own staff = 625*0.4 + 500*0.25 + 400*0.35 = 515

Expected cost of Outside vendor = 850*0.4 + 650*0.25 + 350*0.35 = 625

Expected cost of Combination = 600*0.4 + 400*0.25 + 300*0.35 = 445

Combination will minimize the expected cost

Expected Annual cost = $ 445 (1000s)

(b) Risk profit for optimal decision (Combination) for P(medium) = 0.25 and varying levels of P(high) and P(low) is as follows