Question

1. A company is trying to decide whether to bid for a certain contract or not. They estimate that merely preparing the bid will cost $10000.If their company bids, then they estimate that there is a 50% chance that their bid will be put on the “short-list;” otherwise their bid will be rejected. Once “short-listed” the company will have to supply further detailed information (entailing costs estimated at $5000). After this stage their bid will either be accepted or rejected. The company estimates that the labor and material costs associated with the contract are $127000. They are considering three possible bid prices, namely, $155000, $170000, and $190000. They estimate that the probability of these bids being accepted (once they have been short-listed) is 0.90, 0.75, and 0.35, respectively. What should the company do and what is the expected monetary value of your suggested course of action?

Answer 1

Given that there is 50% chance that their bid will be put on the “short-list;” otherwise their bid will be rejected

So there is 50% chance the bid will be rejected, in that case the expecred loss to the company is 0.5*10000 = $5000

expected loss = probability * cost = 0.5 *10000

In the other case if the bid in the shortlist

The costs involved are $10000 for preparing the bid , $5000 for suppling further detailed information,$127000 for labor and material costs associated with the contract

So the costs will be in total $142000

Whereas the expected value from bid acceptance to the company = 0.9 * $155000 + 0.75 * $170000 + 0.35 * $190000

= $3,35,000

So the expected profit if the bid is shortlisted = 0.5 * (3,35,000 - $142,000)

= 95750

Since there is 50% chance that the bid will be shorlisted

So the total expected value to the company = expected profit if the bid is shortlisted - expected loss if the bid is rejected

= 95750 - 5000

= 90750

So the compay can bid for the project and the expected value will be $90750 to the company