Question

1. YourHome Constuction has received favorable publicity from guest appearances on a public TV home improvement program. Public TV programming decisions seem to be unpredictable, so YourHome cannot estimate the probability of continued benefits from its relationship with the show. Demand for home improvements next year may be low, moderate or high. YourHome must decide now whether to hire more employees, do nothing or develop subcontracts with other home improvement contractors. YourHome has developed the following payoff table:

Potential Demand:

Decision alternatives Low Moderate High

Hire More employees -250,000 100,000 625,000

Subcontract 100,000 150,000 415,000

Do nothing 50,000 80,000 300,000

a. Which alternative is best according to the maximin (pessimistic) approach?

b. Which alternative is best according to the maximax(optimistic) approach?

c. Which alternative is best according to the equal likelihood approach?

d. Assume the following probabilities have been estimated.

Potential Demand

Low Moderate High .35 .55 .10

i. Calculate the EMV for each alternative.

ii. What would you recommend to YourHome if the EMV was used?

iii. Calculate the EVwithPI and the EVof PI for this problem.

iv. How would you interpret the EVof PI?

Answer 1

a)

	Low	Moderate	High	Min
Hire	250000	100000	625000	100000
Sub contract	100000	150000	415000	100000
Do nothing	50000	80000	300000	50000
				100000

maxmin = 100000. So either Hire or Sun contract is best option

b)

	Low	Moderate	High	Max
Hire	250000	100000	625000	625000
Sub contract	100000	150000	415000	415000
Do nothing	50000	80000	300000	300000
			MAXIMAX	625000

Hire employee is the best option

c)

	Low	Moderate	High	Average
Hire	250000	100000	625000	325000
Sub contract	100000	150000	415000	221666.7
Do nothing	50000	80000	300000	143333.3
				325000

Hire employee is best option

d)

i)

	Low	Moderate	High	Expected payoff
	0.35	0.55	0.1
Hire	250000	100000	625000	205000
Sub contract	100000	150000	415000	159000
Do nothing	50000	80000	300000	91500

ii) Expected value for Hire is maximum. So it is recommended to hire more employees.

iii)

EM with PI is

EV|PI = 0.35*250,000+0.55*150,000+0.1*625000 = 232500

EVPI = EV|PI - EVM = 232500-205000 = 27500

iv)

Knowing the perfect information, extra gain will be 27500. So perfect information worth is 27500.