A small parts manufacturer has just engineered a new product for the automotive
ID: 412522 • Letter: A
Question
A small parts manufacturer has just engineered a new product for the automotive industry. In order to produce the part the company can expand existing facilities, acquire a competitor, or subcontract production. The company believes the product will either experience high market demand or low market demand. The company believes the product will either experience high market demand or low market demand, with probabilities of 0.50 and 0.50, respectively.
The following payoff table describes the company’s decision situation (all numbers are in thousands). Note that some numbers are negative. .............................................High Demand........Low Demand Expand Facilities........................1700.......................-1250 Acquire Competitor....................850.......................-475 Subcontract Production............275.......................30
What is the best decision based on optimistic approach? Expand Facilities Acquire Competitor Subcontract Production
What is the best decision based on pessimistic approach? Expand Facilities Acquire Competitor Subcontract Production
How much is the average payoff if the company expands facilities?
How much is the average payoff if the company acquires competitor?
How much is the average payoff if the company subcontracts production?
What is the best decision based on equal likelihood approach? Expand Facilities Acquire Competitor Subcontract Production
How much is the expected payoff if the company expands facilities?
How much is the expected payoff if the company acquires competitor?
How much is the expected payoff if the company subcontracts production?
What is the best decision based on expected value approach? Expand Facilities Acquire Competitor Subcontract Production
How much is the expected payoff if the company has full information about the demand?
Calculate the expected value of perfect information?
How much is the maximum regret of the company if they expand facilities?
How much is the maximum regret of the company if they acquire competitor?
How much is the maximum regret of the company if they subcontract production?
What is the best decision based on minimax regret approach? Expand Facilities Acquire Competitor Subcontract Production
Explanation / Answer
1) Optimistic approach: In this approach, Maximum out of the maximum payoff of each decision for all demand states determines which decision alternative should be chosen.
Maximum payoff of Expand Facilities = MAX(1700,-1250) = 1700
Maximum payoff of Acquire Competitor = MAX(850,-475) = 850
Maximum payoff of Subcontract Production = MAX(275,30) = 275
Maximum out of the above is 1700 pertaining to decision alternative Expand Facilities.
Therefore, best decision based on optimistic approach is Expand Facilities.
2) Pessimitic approach: In this approach, Maximum out of the minimum payoff of each decision for all demand states determines which decision alternative should be chosen.
Minimum payoff of Expand Facilities = MAX(1700,-1250) = -1250
Minimum payoff of Acquire Competitor = MAX(850,-475) = -475
Minimum payoff of Subcontract Production = MAX(275,30) = 30
Maximum out of the above is 30 pertaining to decision alternative Subcontract Production.
Therefore, best decision based on pessimistic approach is Subcontract Production.
3)
Average payoff if the company expands facilities = AVERAGE(1700,-1250) = 225
Average payoff if the company acquires competitor = AVERAGE(850,-475) = 187.5
Average payoff if the company subcontracts production = AVERAGE(275,30) = 152.5
4) The maximum value of the above average payoff is 225 pertaining to Expand Facilities.
Therefore, Best decision based on equal likelihood approach is Expand Facilities.
5) Use Multiply the payoff by corresponding probability of low and high demand.
Expected payoff if the company expands facilities = 1700*0.5+(-1250)*0.5 = 225
Expected payoff if the company acquires competitor = 850*0.5+(-475)*0.5 = 187.5
Expected payoff if the company subcontracts production = 275*0.5+30*0.5 = 152.5
6) Maximum expected payoff is 225, pertaining to Expand Facilities.
Therefore, Best decision based on expected value approach is Expand Facilities.
7) Expected payoff if the company has full information about the demand (EVwPI) = 1700*0.5 + 30*0.5 = 865
8) Expected Value of Perfect Information (EVPI) = EVwPI - EVmax = 865 - 225 = 640
9)
Maximum regret if they expand facilities = MAX(MAX(1700,850,275)-1700, MAX(-1250,-475,30)-(-1250)) = MAX(0,1280) = 1280
Maximum regret if they acquire competitor = MAX(MAX(1700,850,275)-850, MAX(-1250,-475,30)-(-475)) = MAX(850,505) = 850
Maximum regret if they subcontract production = MAX(MAX(1700,850,275)-275, MAX(-1250,-475,30)-(30)) = MAX(1425,0) = 1425
10)
Minimum out of the Maximum regrets determined above is 850 pertaining to decision Acquire Competitor.
Therefore, the best decision based on minimax regret approach is Acquire Competitor.
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