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In: Operations Management

Question 2 A manager is trying to decide whether to build a small, medium, or large...

Question 2 A manager is trying to decide whether to build a small, medium, or large facility. Demand can be low, average, or high, with the estimated probabilities being 0.25, 0.40, and 0.35, respectively.

A small facility is expected to earn an after-tax net present value of just $18,000 if demand is low. If demand is average, the small facility is expected to earn $75,000; it can be increased to medium size to earn a net present value of $60,000. If demand is high, the small facility is expected to earn $75,000 and can be expanded to medium size to earn $60,000 or to large size to earn $125,000.

A medium-sized facility is expected to lose an estimated $25,000 if demand is low and earn $140,000 if demand is average. If demand is high, the medium-sized facility is expected to earn a net present value of $150,000; it can be expanded to a large size for a net payoff of $145,000.

If a large facility is built and demand is high, earnings are expected to be $220,000. If demand is average for the large facility, the present value is expected to be $125,000; if demand is low, the facility is expected to lost $60,000.

Which alternative is best, according to each of the following decision criterion?

a) Maximin

b) Maximax

c) Minimax regret

Question 3 (40 points). Draw a decision tree for the three options described in Question 2. What should management do to achieve the highest expected payoff?

Expert Solution

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a. Draw a decision tree for this problem.

b. What should management do to achieve the highest expected payoff?

The highest payoff is with LARGE size= 112000

	LOW	AVERAGE	HIGH
prob	0.25	0.4	0.35	expected value
SMALL	18000	75000	75000	60750
MEDIUM	-25000	140000	150000	102250
LARGE	-60000	125000	220000	112000

c. Which alternative is best, according to each of the fol- lowing decision criterion?
Maximin

SMALL size. This is because the min of all 3 options is 18000, -25000, -60000. The maximum out of these is 18000

Maximax

LARGE size. This is because the max of all 3 options is 75000, 150000, 220000. The maximum out of these is 220000

Minimax regret

MEDIUM size. This is because the min of the max regret values is 75000

REGRET TABLE

	LOW	AVERAGE	HIGH	max regret
prob	0.25	0.4	0.35
SMALL	78000	0	0	78000
MEDIUM	35000	65000	75000	75000
LARGE	0	50000	145000	145000

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keosha answered 6 months ago

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