1. Consider a case where the management is facing with 3 options to choose from.

Question

1. Consider a case where the management is facing with 3 options to choose from. The payoffs and probability associated with each of the scenario is also estimated and provided. Based on the information tabulated below, calculate the EVwPI (expected value with perfect information) and recommend what should be the maximum amount that the management should pay for the perfect information that can help them to make the best decision.

Decision alternative favourable market unfavourable market

Expensive system 10,000 -8,000

Les expensive system 8,000 - 4,000

No system 0 0

Probability 0.4 0.6

Explanation / Answer

Expected value with perfect information (EVwPI) = Maximum payoff under favorable market*.4 + maximum payoff under unfavorable market*.6

Expected value with perfect information (EVwPI) = 10000*.4 + 0*.6

Expected value with perfect information (EVwPI) = $4000

To calculate the value of perfect information, we also need to be calculated the maximum expected value of payoff among all the option.

Expected monetary value (EMV) for expensive system = 10000*.4 -8000*.6 = -$800

Expected monetary value (EMV) for less expensive system =8000*.4 -4000*.6 = $800

Expected monetary value (EMV) for no system =$0

Above all three, the maximum EMV is of less expensive system, hence this system will be selected for execution if prefect information is not available. It will be called as expect value without perfect information.

Now,

Value of perfect information = EVwPI – EvwoPI = 4000 – 800

Value of perfect information = $3200

So, the value of perfect information is $3200.

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