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 0.58 and a 0.42 probability of 80,000 at $620. If, however, he uses the value analysis team (option b), the firm expects sales of 90,000 units at $760 with a probability of 0.73 and a 0.27 probability of 65,000 units at $760. Value engineering, at a cost of 115,000, is only used in option b. Which option has the highest expected monetary value (EMV)?

The EMV for option a is $____ and the EMV for option b is $_____ Therefore, option ___A or B____ has the highest expected monetary value.

Explanation / Answer

Expected monetary value of any option

= Sum ( Probability x Price/ unit x Sales in units) – Value Engineering cost ( $115,000)

Therefore ,

Expected Monetary Value ( EMV ) of option a

= 0.58 x 620 x 85000 + 0.42 x 620 x 80,000 – 115,000

= 30566000 + 20832000 – 115,000

= 51283000

Expected Monetary Value ( EMV ) of Option b

= 0.73 x 760 x 90,000 + 0.27 x 760 x 65000 – 115,000

= 49932000 + 13338000 – 115000

= $63155000

Option B has the Highest expected monetary value

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