Question

James Madison, president of Madison Manufacturing, inc,. is considering whether to build more manufacturing plants in Madison Wisconsin. He is considering three sizes of plant: Small, Medium, or Large. At the same time, an uncertain economy makes ascertaining the demand for the new plants difficult. His management team has prepared the following cost payoff table (in thousands of dollars).

Decision Alternatives States of Nature

Good Economy Fair Economy Poor Economy Expected Value

Small plant d1 $650 $650 $600 ?

Medium plant d2 $900 $600 $300 ?

Large plant d3 $800 $650 $500 ?

Probability Factor 40% 35% 25% ?

Best decision Alternative= ?

1. Calculate the expected value for each decision alternative using Expected Value Strategy in Excel Spread Sheet.

2. Specify the best decision alternative to minimize cost.

Answer 1

The expected value of any decision alternative is

1. Prepare the following sheet

get this

From the above the expected cost payoff for different decision alternative are

• Small plant d1:  $637,500.00
• Medium plant d2:  $645,000.00
• Large plant d3 :  $672,500.00

2. The decision alternative d1 to build a small plant has the minimum expected cost.

ans: the best decision alternative to minimize cost is to build a Small plant : d1

Note: The above cost table looks slightly off. The cost table actually looks like a profit table. That is during a good economy, you are expected to have a larger profit than when the economy is poor. The payoff table exactly has that structure.

So if at all the mention of cost payoff is a mistake and it is a profit pay off then the best decision alternative would be to maximize profit.

ans: the best decision alternative to maximize profit would be to build Large plant : d3.