rustMe.Inc a software development corporation has determined that it needs to ex
ID: 2922607 • Letter: R
Question
rustMe.Inc a software development corporation has determined that it needs to expand its current capacity. The decision has come down to whether to expand now with a large facility incurring additional costs and taking the risk that the demand will not materialize or to undertake a small expansion knowing that the decision will have to be reconsidered in five years.Management has estimated the following chances for demand: The likelihood of demand being high is 0.6 Likelihood of demand being low is 0.4 Profits for each alternative have been estimated: Large expansion has an estimated profitability of either $1,000,000 or $600,000, depending on whether demand turns out to be high or low. Small expansion has a profitability of $500,000 assuming that demand is low. Small expansion with an occurrence of high demand would require considering whether to expand further. If the company expands at that point, you can be 100% certain that the profitability is expected to be $700,000. If it does not expand further, you can be 100% certain that the profitability is expected to be $500,000. Provide the expected value for the large expansion and the small expansion in the field below and which option would you recommend?
Explanation / Answer
Pr(High Demand) = 0.6
Pr(low Demand) = 0.4
Large expendsion :
Profit when high demand = $ 1,000,000
Profit when low demand = $ 600,000
Small Expnaison:
Profit when low demand = $ 500,000
Profit when high demand (Decision 1 - expandsion) = $ 700,000
Profit when high demand (Decision 2 - expansion) = $ 500,000
Expected Value for the large expansion= Pr(High Demand) * Pr(Profit ) + Pr(Low Demand) * Pr( Profit)
= 0.6 * 1000000 + 0.4 * 600000 = $ 840,000
Expected Value for the small expansion and later expanded = Pr(High Demand) * Pr(Profit ) + Pr(Low Demand) * Pr( Profit)
= 0.6 * 500000 + 0.4 * 700000 = $ 580,000
Expected Value for the small expansion and expanded = 0.6 * 500000 + 0.4 * 500000 = $ 500,000
We would recommend that the large expansion as the expected value for the large expansion.
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