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	650	450	300
Outside vendor	800	600	350
Combination	700	600	400

1. If the demand probabilities are 0.35, 0.25, and 0.4, which decision alternative will minimize the expected cost of the data processing operation? (choices are: Own Staff, Outside Vendor, or Combination)

What is the expected annual cost associated with that recommendation? If rerequired, round your answer to the nearest dollar.

Expected annual cost = $   

b. Construct a risk profile for the optimal decision in part (a).

Cost (in thousands of dollars)	Propability
	0.35
	0.25
	0.4
	1.0

What is the probability of the cost exceeding $500,000? If required, round your answer to two decimal places.

Probability =

Answer 1

a)

The expected annual costs are obtained using the formula,

For Own staff,

For Outside vendor

For Combination

Hence the minimum annual cost is when continuing with its own staff.

Expected annual cost = $ 460,000

b)

Since minimum annual cost is occurred when continuing with its own staff, the risk profile is,

Cost (in thousands of dollars)	Probability
650	0.35
450	0.25
300	0.4
Total	1

The probability of the cost exceeding $500,000 is obtained by calculating the z score,

From the probability distribution above,

X	P(X)	X^2P(X)
650	0.35	147875
450	0.25	50625
300	0.4	36000
	Total	234500

The required probability,