1. Your company has a customer who is shutting down a production line, and it is

Question

1. Your company has a customer who is shutting down a production line, and it is your responsibility to dispose of the extrusion machine. The company could keep it in inventory for possible future product and estimates that the reservation value is $250,000. Your dealings on the second-hand market lead you to believe that there is a 0.4 chance a random buyer will pay $300,000, a 0.25 chance the buyer will pay $350,000, a 0.1 chance the buyer will pay 400,000, and a 0.25 chance it will not sell. If you must commit to a posted price, what price maximizes profits?

Explanation / Answer

If you must commit to a posted price, $400,000 would maximize profit, but there’s only a 10% chance it would sell. Since the expected value is $247,500, the best option would be to sell it for $300,000.

0.4(300,000) + 350,000(0.25) + 400,000(0.10) + 0.25(0)

120,000+87,500+40,000+0

$247,500

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