Your firm faces considerable revenue uncertainty because you have to negotiate c
ID: 1167959 • Letter: Y
Question
Your firm faces considerable revenue uncertainty because you have to negotiate contracts with several customers. You forecast a 20 percent chance that your revenues will be $200,000, a 30 percent chance that your revenues will be $300,000, and a 50 percent chance that your revenues will be $500,000. Your costs are also uncertain because the prices of your supplies fluctuate considerably. You forecast a 40 percent chance that your costs will be $400,000 and a 60 percent chance that your costs will be $250,000. Use Excel to set up a decision tree for your profit forecast (it does not matter whether costs or revenues come first). How many possible profit outcomes do you have? What is your expected profit?
Explanation / Answer
Decision Tree
Cost ($)
Revenue ($)
Profit($)
2,00,000
-200000
0.2
0.08
4,00,000
3,00,000
-1,00,000
0.4
0.3
0.12
5,00,000
1,00,000
0.5
0.2
Expected Profit =
70,000
2,00,000
-50,000
0.2
0.12
2,50,000
3,00,000
50,000
0.6
0.3
0.18
5,00,000
2,50,000
0.5
0.3
From the expected profit and cost data we have 6 possible outcomes and the expected profit is found to be $70,000.
Decision Tree
Cost ($)
Revenue ($)
Profit($)
2,00,000
-200000
0.2
0.08
4,00,000
3,00,000
-1,00,000
0.4
0.3
0.12
5,00,000
1,00,000
0.5
0.2
Expected Profit =
70,000
2,00,000
-50,000
0.2
0.12
2,50,000
3,00,000
50,000
0.6
0.3
0.18
5,00,000
2,50,000
0.5
0.3
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