Question

The management of TTT Co must choose whether to go ahead with either of two mutually exclusive projects, A and B. The expected profits are as follows.

	Profit if there is strong demand	Profit if there is moderate demand	Profit if there is moderate demand
Option A	$ 8,000	$ 2,400	$ (2,000)
Option B	$ 3,000	$ 2,000	$ 1,000
Probability of demand	0.2	0.3	0.5

Required:

(a) Based on expected values, what would be the decision (project A or project B), if no information about demand were available.

(b) Calculate the value of perfect information about demand.

Answer 1

Solution(a)
	Option A
	Situation	Profit	Probability	Expected value
	Strong demand	8000	0.2	1600
	Moderate demand	2400	0.3	720
	weak demand	-2000	0.5	-1000
			Total	1320
	Option B
	Situation	Profit	Probability	Expected value
	Strong demand	3000	0.2	600
	Moderate demand	2000	0.3	600
	weak demand	1000	0.5	500
			Total	1700
	Since expected value in "option B" is higher, Option would be choosen
Solution(b)
	If information about the state of consumer demanad is available, option A would be preferred if forcast demand is strong and option A would be preferred if forcast demand is moderate and option B would be preferred if forcast demand is weak.
	Then,
	Situation	Profit	Probability	Expected value
	Strong demand	8000	0.2	1600
	Moderate demand	2400	0.3	720
	weak demand	1000	0.5	500
	Expected value with perfect information	2820
	Less: Expected value if selecting B	-1700
	Value of perfect information		1120