Question

During a co-op term, a BBA student worked for a company that manufactured screens for cell phones. She was asked to determine if a new product, a screen defroster (for use by skiers and others spending time outdoors in the cold) should be manufactured in the current production facility (in-house) or out-sourced.   The payoff table (in $ 000) is shown below along with probability information the marketing department provided.

	Probability	Action
Event		In-house	Out-source
Recession	0.3	$150	$220
Stable	0.2	$240	$350
Expansion	0.5	$390	$300

1. Determine the optimal action based on Maximin.    

2. Calculate the Expected Monetary value (EMV) for each action.   Based on EMV what is your decision?

3. Calculate the Expected Value of Perfect Information (EVPI).   

Answer 1

(the numbering seems to be mistyped in question's parts i am numbering them a,b,c)

a.

minimum payoffs :

in-house = $150

out-source = $220

therofore fir maximin we take the maximum of the minimum payoffs

therefore according to maximin out-source is chosen

b.

EMV = sum of P(event)*payoff(event)

EMV (in house) = 0.3*$150 + 0.2*$240 + 0.5*$390

= $ 288

EMV (out source) = 0.3*$220 + 0.2*$350 + 0.5*$300

= $ 286

based on EMV we would choose higher EMV action which is in house (EMV = $288)

c.

EVPI = ( sum of (maximum payoff)*P(event) ) - highest EMV

= ( 0.3*220 + 0.2*350 + 0.5*390 ) - 288

= $ 43

EVPI = $43

(please UPVOTE)