Question

The ABC Co. is considering a new consumer product. They believe there is a probability of 0.30 that the XYZ Co. will come out with a competitive product. If ABC adds an assembly line for the product and XYZ does not follow with a competitive product, their expected profit is $45,000; if they add an assembly line and XYZ does follow, they still expect a $12,000 profit. If ABC adds a new plant addition and XYZ does not produce a competitive product, they expect a profit of $450,000; if XYZ does compete for this market, ABC expects a loss of $80,000. If ABC does nothing, XYZ does nothing.

(a) Determine the EMV of each decision.

(b) Determine the EOL of each decision.

(c) Compare the results of (a) and (b).

(d) Calculate the EVPI.

Answer 1

Answer:

Given Data

a) in order to calculate EMV for each decision , we need to make a table

paayoff table	Monetary value(XYZ competes with a product)	Monetary value(XYZ doesn't competes with a product)	Calculated EMV
Company ABC adds an assembly fine	+$12000	+$45000	$35100
Company ABC adds a new plant addition	-$80000	+$45000	$291000
Probability	0.3	0.7

Calculation of EMV for the case when ABC adds an assembly line

= 12000 * 0.3 + 45000 * 0.7

= $ 35100

Calculation of EMV for the case when ABC adds a new plant addition

= - 80000 * 0.3 + 45000 * 0.7

= $ 291000

Hence , as per the EMV value , the company should decide to add a new plant addition.

b) In order to calculate EOL for each decision , we should again need a table.

Opportunity loss table	Monetary Regret(XYZ competes with a product)	Monetary Regret(XYZ doesn't competes with a product)	EOL
ABC adds an assembly fine	+$12000-$12000=$0	+$45000-$45000=$405000	$283500
ABC adds a new plant addition	$12000-(-$80000)=$92000	+$45000-$450000=$0	$27600
Probability	0.3	0.7

Calculation of EOL for the case when ABC adds an assembly line

= 0 *0.3 + 405000 * 0.7

= $ 283500

Calculation of EMV for the case when ABC adds a new plant addition

= $ 92000 * 0.3 + 0 * 0.7

= $ 27600

Hence , as per the EOL value , the company ABC should decide to ADD a new plant addition because the EOL value is the least in that case.

calculation of EOL for the case when ABC adds an assembly line = 0 0.3 + 405000 0.7 = $ 283500

Calculation of EMV for the case when ABC adds a new plant addition = $92000*0.3 + 0 * 0.7 = $27600

Hence, as per the EOL value, the company ABC should decide to ADD a new plant addition because the EOL value is the least in that case.

c) The EMV value is representative of monetary profit and hence, the investment where EMV is high, that is where the company should invest. On the other hand, the EOL value is representative of opportunity loss and hence, the investment where EOL is low, that is where the Company should invest.

In the above scenario, the EMV value is highest and the EOL value is lowest for the same decision, which is to add a new plant addition.

Moreover, the sum of EMV and EOL returns the same value for both the cases

viz.

$35100 + $283500 = $318600 and $291000 + $27600 = $318600

d) The value of EVPI is always the same as that of the lowest EOL value

Hence EVPI = $27600

Thank you.

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