The owner of a landscaping company is considering what to do with her company ov
ID: 2751437 • Letter: T
Question
The owner of a landscaping company is considering what to do with her company over the next two years. The last couple of years, her business has experienced a substantial increase in demand. Lately, however, there has been talk of a developer planning to build a large industrial park in the county. The landscaping company owner forecasts that potential service contracts with the new industrial park complex will increase her demand. To be prepared for the opportunities if the industrial park is built, the owner sees three options for her company: the first is to undertake a one-time major expansion of her business, the second is to commit to a minor expansion this year and another minor expansion in the second year, the third option is to simply wait and do nothing. The probability that the developer will build the industrial park is estimated at about 0.30. The assumptions and conditions are summarized below.
a. With a major expansion will result in two-year service revenues of $300,000 if the industrial park is built and $100,000 if it is not built.
b. A two-year commitment to two minor expansions will result in two-year service revenues of $250,000 if the industrial park is built and $100,000 if it is not built.
c. Waiting and doing nothing will result in service revenues of $100,000 whether or not the industrial park is built.
The owner would like to determine the best alternative action.
Problem Questions:
(1) Develop the appropriate pay off table.
(2) Draw the decision tree.
(3) Which alternative has the highest expected monetary value (EMV) under risk, and therefore would be the best alternative?
(4) What is the expected value with perfect information (EVwPI)?
(5) What is the expected value of perfect information (EVPI)?
Challenge question:
(6) If the cost of a major expansion is $70,000, and the total cost of two minor expansions is $90,000, what would be the EP (expected payoff or profit) for each alternative? Given this new information, which alternative would be the best?
Explanation / Answer
Answer :-
The probability that the developer will build the industrial park is estimated at about 0.30.
Option - 1
Cost of Major Expansion = $ 70000
Expected Pay-off or Profit = Total Revenue - Total Cost
= 160000 - 70000
= $ 90000
Option - 2
Cost of two Major Expansion = $ 90000
Expected Pay-off or Profit = Total Revenue - Total Cost
= 145000 - 90000
= $ 55000
Option - 3
Waiting and doing nothing will result in service revenues of $100,000 whether or not the industrial park is built.
Total Revenue = $ 100000
Total cost = 0
Expected Pay-off or Profit = Total Revenue - Total Cost
= 100000 - 0
= $ 100000
Option - 3 is the beat option, because its expected pay-off or profit higher than the other options.
Particulars Amount Probability (Pi) Total Revenue Build the Industrial Park 300000 .30 =(300000 * .30) = 90000 Not Build the Industrial Park 100000 .70 = 70000 TOTAL 160000Related Questions
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