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In: Operations Management

A manager is trying to decide whether to build a small, medium, or large facility. Demand...

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

D)Draw a decision tree for the three options described in the question. What should management do to achieve the highest expected payoff?

Expert Solution

Pay-off Matrix:

Facility	Low Demand	Avg Demand	High Demand
Small	18000	60000	140000
Medium	-25000	140000	145000
Large	-60000	125000	220000

Ans 1) MaxiMin

In this method, we have to find the minimum amount of return among three scenario and then select the facility having maximum value.

As per MaxiMIn strategy, Small Facility is the best alternative:

Facility	Low Demand	Avg Demand	High Demand	MaxiMin
Small	18000	60000	140000	18000	(Maximum)
Medium	-25000	140000	145000	-25000
Large	-60000	125000	220000	220000

Decision: Small Facility

Ans 2) MaxiMax

In this method, we have to find the maximum amount of return among three scenario and then select the facility having maximum value.

Decision: Large Facility

Ans 3) MinMax Regret

Decision: Medium Facility

keosha answered 2 hours ago

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