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

Question

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 a possible future product and estimates that the reservation value is $250,000. Your dealings on the secondhand 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 will maximize profit, but having only a 10% chance it would sell. Since the expected value is $247,500, the best option could 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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