Question

The Candy Town Company, a competitor of the SweetTooth Candy Company, knows it will need 40,000 lbs of sugar six months from now to implement its production plans. James Taffy, Candy Town's purchasing manager, has essentially two options for acquiring the needed sugar. One option is to buy the sugar at the going market price when they need it, six months from now. Mr. Taffy has assessed the probability distribution for the possible prices of sugar six months from now (in dollars per pound) as shown below:

Price in 6-month   Probability

    $0.078            0.10
     0.086    0.20
     0.094    0.20
     0.102    0.20
     0.110    0.20
     0.118    0.10    

The second purchasing option is to buy a futures contract now. The contract guarantees delivery of the sugar in six months but the cost of purchasing it will be based on today's market price. Assume that possible sugar futures contracts available for purchase are for 10,000 lbs, 20,000 lbs or 40,000 lbs only. No futures contracts can be purchased or sold in the intervening months. The Candy Town Company will buy the total of 40,000 lbs of sugar in one way or another. The price of sugar now is $0.0851 per pound. The transaction costs for 10,000 lbs, 20,000 lbs and 40,000 lbs futures contracts are $150, $200, and $350, respectively.

(You may choose one answer more than once.)

Question 1 options:

123456789 The EMV of buying the 10,000 lbs futures contract is 123456789 If the current sugar price per pound is $0.092, the best decision alternative by the EMV method is 123456789 The best decision alternative by the Maximin method is 123456789 The best decision alternative by the EMV method is 123456789 The EMV of buying the 40,000 lbs futures contract is 123456789 The best decision alternative by the Maximax method is 123456789 The EMV of not buying a futures contract is The EMV of not buying a futures contract is 123456789 The EMV of buying the 20,000 lbs futures contract is

1. 3683 2. 3754 3. 3862 4. 3920 5. 3941 6. Buy no futures contract 7. Buy the 10,000 lbs futures contract 8. Buy the 20,000 lbs futures contract 9. Buy the 40,000 lbs futures contract

Answer 1

1. The EMV of buying a 10000 bls futures contract is $150+10000*0.0851 + 30000 * 0.098 = $3941. Here 30000 lbs of sugar is brought after 6 months for which the expected price is 0.098 and rest if brought via a futures contract.

2. If current sugar price is 0.92, the EMV of future contracts for 10000, 20000 and 40000 is 4010, 4000, 4030 respectively. The EMV for buying it after 6 months is 3920 which is the least. Hence the correct option is buy no future contract.

4. The best decision by EMV method is buy the 40000 lbs futures contracts as the EMV for 10000, 20000, 40000 and buying it after 6 months are 3941, 3862, 3754 and 3920 respectively.

5. The EMV of buying 40000 lbs futures contract is $350+40000*0.0851 = $3754

7. The EMV of not buying a futures contract is same as buying it at the end of six month. The estimate price of sugar at the end of six month is given by sum of product of probabilities and the price at that probabilities which is 0.098. Hence the EMV is 40000*0.098 = $3920

8. The EMV of buying a 20000 lbs futures contract is 20000*0.0851+2000 + 20000 * 0.098 = $3862