Question

Hudson Corporation is considering three options for managing its data warehouse: 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 650 600 500 Outside vendor 900 650 350 Combination 800 650 500 (a) If the demand probabilities are 0.3, 0.5, and 0.2, which decision alternative will minimize the expected cost of the data warehouse? - Select your answer -Own staffOutside vendorCombinationItem 1 What is the expected annual cost associated with that recommendation? Enter your answer in thousands dollars. For example, an answer of $200 thousands should be entered as 200,000. 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 $625,000 ? If required, round your answer to two decimal places. Probability =

Answer 1

The expected value (EV) of a decision alternative is defined as follows:

Where,

N = the number of states of nature

P(Sj) = The probability of states of nature

Vij = The payoff corresponding to the decision alternative di and state of the nature Sj

EV(own staff) = 0.3 x (650) + 0.5 x (600) + 0.2 x (500) = 195+300+100 = 595

EV(Outside vendor) = 0.3 x 900 + 0.5 x 650 + 0.2 x 350 = 270+325+70=665

EV(Combination) = 0.3 x 800 + 0.5 x 650 + 0.2 x 500 = 240 + 325 + 100 = 665

From the above calculation, it can be derived that the minimum cost of operation is $ 595,000, which is obtained for selecting Own Staff. Hence, Own Staff is the correct Option.

The expected annual cost is $ 595,000.

(b)

The risk profile for the own staff is shown below:

Demand	Cost	Probability
Low	$ 500,000	0.2
Medium	$ 600,000	0.5
High	$ 650,000	0.3

From the table, it is seen that, $625,000 will lie above the medium cost valuei.e., $600,000. Hence, the required probability will be for the high demand which is 0.3 or 30%.