Copyright

A firm must decide whether to construct a small, medium, of large stamping plant. A consultant's ...

Question:

A firm must decide whether to construct a small, medium, of large stamping plant. A consultant's

report indicates a .20 probability that demand will be low and an .80 probability that demand will

be high.

If the firm builds a small facility and demand tums out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million.

The firm could build medium-size facility as a hedge: If demand tums out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million,

If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million.

a. Analyze this problem using a decision tree.

b. What is the maximum alternative?

c. Compute the EVPI and interpret it.

Decision Tree:

A decision tree helps management while determining the best alternative for choosing the best option for investment. A decision tree is split into nodes and sub-nodes for mapping the different issues of the management.

Answer and Explanation:

Become a Study.com member to unlock this answer! Create your account

View this answer

a)

Decision Tree

Decision Tree

b) Maximum alternative:

Small:

There are two option in the case of higher demand and higher return value

=0.2*42 +...

See full answer below.


Learn more about this topic:

Loading...
What Is a Decision Tree? - Examples, Advantages & Role in Management

from

Chapter 2 / Lesson 12
61K

Clearly identifying all possible solutions for a given decision is an important part of successful management. In this lesson, you will learn how to use a decision tree to identify and select possible courses of action.


Related to this Question

Explore our homework questions and answers library