MacDonald Products, Inc., of Clarkson, New York, has the option of (a) proceedin

Question

MacDonald Products, Inc., of Clarkson, New York, has the option of (a) proceeding immediately with production of a new top-of-the-line stereo TV that has just completed prototype testing or (b) having the value analysis team complete a study If Ed Lusk, VP for operations, proceeds with the existing prototype (option a), the firm can expect sales to be 85,000 units at $620 each, with a probability of 0.75 and a 0.25 probability of 60,000 at $620. If, however, he uses the value analysis team (option b), the firm expects sales of 90,000 units at $770, with a probability of 0.66 and a 0.34 probability of 70,000 units at $770. Value engineering, at a cost of $90,000, is only used in option b. Which option has the highest expected monetary value (EMV)? The EMV for option a is $1 and the EMV for option b is $ . Therefore, option | | has the highest expected monetary value. (Enter your responses as integers.)

Explanation / Answer

We assume :

P = Price / unit

FC = Fixed cost

R = Variable cost / unit

Let the breakeven quantity = Q

Since at break even quantity Total revenue = Total cost ,

Therefore ,

Total revenue = Fixed cost + Total variable cost

Or, Price/ unit x Q = Fixed cost + Variable cost/ unit X Q

Or, P.Q = FC + R.Q

Or, ( P – R) x Q = FC

Or, Q = FC / ( P – R )= 2R/ ( 2FC – R) = 2R/ ( 2 x 2R – R ) = 2R/3R = 2/3 = 0.666

Therefore,

Q = 0.666

Therefore, Q = 0.666

Expected Monetary value for any option

= Sum of ( Expected sales x Price/ unit x Probability ) – Cost of value engineering

Therefore ,

EMV for option a = ( 85,000 x 620 x 0.75 + 60,000 x 620 x 0.25 ) – 0 = 39,525000 + 9,300000 = $48825000

EMV for option b = ( 90,000 x 770 x 0.66 + 70,000 x 770 x 0.34 ) - 90,000 = $45738000 + $18326000 – $ 90,000 = $63974000

EMV for option a = $48825000 and EMV for option b = $63974000

Therefore, Option b has highest expected value

EMV for option a = $48825000 and EMV for option b = $63974000

Therefore, Option b has highest expected value

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