Question

Hudson Corporation is considering three options for managing its data processing operation: 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 625 500 400 Outside vendor 850 650 350 Combination 600 400 300 If the demand probabilities are 0.4, 0.25, and 0.35, which decision alternative will minimize the expected cost of the data processing operation? Combination What is the expected annual cost associated with that recommendation? If required, round your answer to the nearest thousand of dollars. Expected annual cost = $ fill in the blank 2 Construct a risk profile for the optimal decision in part (a). Cost Probability fill in the blank 3 0.4 fill in the blank 4 0.25 fill in the blank 5 0.35 1.0 A graphical representation of the risk profile is also shown

Answer 1

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V11	625	V21	850	V31	600
V12	500	V22	650	V32	400
V13	400	V23	350	V33	300
P(s1)	0.4
P(s2)	0.25
P(s3)	0.35

Let	Own staff	d1		High	s1
	Outside vendor	d2		Medium	s2
	Combination	d3		Low	s3

(a)	As the expected value is the sum of the products of the probabilities and the corresponding costs.
		N
	EV(d1)=	∑ P(sj)V1j	515
		j=1
		N
	EV(d2)=	∑ P(sj)V2j	625
		j=1
		N
	EV(d3)=	∑ P(sj)V3j	445
		j=1
	The lower expected value is EV(d3), which implies that the decision of combination venodrs will minimize the expected cost of the data processing operation
	Moreover ,the expected annual cost associated with the recommendation is EV(d3)	410
b)	The risk profile for combinations of vendors is shown below
	Demand	cost	probaility
	Low	300	0.4
	medium	400	0.25
	High	600	0.35
	From the above table , we can say that $445 would lie above the Low cost value i.e. 300 . Hence the required probability is 0.4
c)	Result of part(a)	EVwoPI = EV(d2) =	445
	when the demand is high , then it is best to choose alternative d3 with cost 600 as this option has the lowest cost in this case.
	when the demand is medium , then it is best to choose alternative d3 with cost 400 as this option has the lowest cost in this case.
	when the demand is low , then it is best to choose alternative d3 with cost 300 as this option has the lowest cost in this case.
	The expected value is the sum of the products of the probabilities and the corresponding costs.
		N
	EVwPI=	∑ P(sj)V1j	=	Probaility * min cost of each scenario
		j=1		445
	The expected value of perfect information is the absolute difference of the expected value with perfect information decreased by the expected value without perfect information.
		EV PI = |EV w PI - EV w0 PI |=	|445 - 445 | =	0