Part 1 of 3
Kenneth Brown is the principal owner of Brown Oil, InC. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:
Equipment Favorable Market ($)
with probability 70% Unfavorable Market ($)
with probability 30%
Sub 100 300,000 –200,000
Oiler J 250,000 –100,000
Texan 75,000 –18,000
For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.
Although Ken Brown is the principal owner of Brown Oil, his brother Bob is credited with making the company a financial success. Bob is vice president of finance. Bob attributes his success to his pessimistic attitude about business and the oil industry.
Question 1
If Bob would want to base his decision on the Maximin criterion, then which equipment would he choose?
A. Sub 100
B. Oiler J
C. Texan
D. The same as his Brother Ken’s choice
Question 2
Based on the above information, the Expected Monetary Value (EMV) of Sub 100 is ___?__ (Please round to a whole dollar.)
Question 3
Based on the above information, the Expected Monetary Value (EMV) of Oiler J is ___?__. (Please round to a whole dollar.)
Question 4
If Ken would want to maximize the Expected Monetary Value (EMV), then he should choose __________.
A. Sub 100
B. Oiler J
C. Texan
Question 5
If Ken believes that Sub 100 cannot get $300,000 even in a favorable market, then this figure needs to be at least ___?____less for Ken to change his decision. (Please round to a whole dollar.)Hint: You may want to use the What-If-Analysis Goal Seek Tool in Excel as described in Week 1 PPP Slides (1-30).
Part 2 of 3
Megley Cheese Company is a small manufacturer of several different cheese products. One of the products is a cheese spread that is sold to retail outlets. Jason Megley must decide how many cases of cheese spread to manufacture each month. The probability that the demand will be six cases is 0.1, for 7 cases is 0.3, for 8 cases is 0.5, and for 9 cases is 0.1. The cost of every case is $45, and the price that Jason gets for each case is $95. Unfortunately, any cases not sold by the end of the month are of no value, due to spoilage.
Hint: You need to fill in the following table and be careful with the waste whenever production exceeds consumption or the forgone revenue if supply/production falls short of demand.
Profit Demand is 6 Demand is 7 Demand is 8 Demand is 9
Probability
Production is 6
Production is 7
Production is 8
Production is 9
Question 6
The Expected Monetary Value (EMV) of producing 6 cases of cheese spread is ___?___. (Please round to a whole dollar.)
Question 7
The Expected Monetary Value (EMV) of producing 9 cases of cheese spread is ___?___.. (Please round to a whole dollar.)
Question 8
John should manufacture _________ cases of cheese spread.
A.6
B.7
C.8
D.9
Part 3 of 3
A group of medical professionals is considering the construction of a private clinic. If the medical demand is high (i.e., there is a favorable market for the clinic), the physicians could realize a net profit of $100,000. If the market is not favorable, they could lose $40,000. Of course, they don’t have to proceed at all, in which case there is no cost. In the absence of any market data, the best the physicians can guess is that there is a 50–50 chance the clinic will be successful.
Question 9
Construct a decision tree by fill-in the blanks below in reference to the following chart.
The decision choice at Decision 1 is and that at Decision 2 is Event 1 is and Event 2 is .
The probability for Prob1 is and that for Prob2 is .
Payoff 1 is and Payoff 2 is .
EMV 1 is and EMV 2 is .
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