Myraa airlines decided to offer direct service from Akron to Clearwater beach, F

ID: 453259 • Letter: M

Question

Myraa airlines decided to offer direct service from Akron to Clearwater beach, Florida. Management must decide between full-price service using a company’s new fleet of jet aircraft and a discount-service using smaller capacity commuter planes. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service on Clearwater beach: high, moderate, and low. The following table shows the estimated quarterly profits (in thousands of dollars): Service Demand for service High Medium Low Full price 900 760 –430 Discount 710 650 350 The probabilities for the demand is P(High) = 0.3, P(Medium) = 0.5, and P(Low) = 0.2, respectively. a. What is the optimal decision strategy if perfect information were available? b. What is the expected value for the decision strategy developed in part a? c. Using the expected value approach, what is the recommended decision without perfect information? What is its expected value? d. What is the expected value of perfect information?

Explanation / Answer

High

Medium

Low

Probability

0.3

0.5

0.2

Full Price

900

760

-430

564

EV1

Discount

710

650

350

608

EV2

àEVmax

a. What is the optimal decision strategy if perfect information were available?

As evident in the payoff table, if perfect information were available, the optimal strategy is to Sell at full price in case of high and medium demand, and to sell at discount in case of low demand.

b. What is the expected value for the decision strategy developed in part a?

EVwPI = 0.3*900 + 0.5*760 + 0.2*350 = 720

c. Using the expected value approach, what is the recommended decision without perfect information? What is its expected value?

Without perfect information, the recommended decision is to sell at discount, Expected value is

EVmax = 0.3*710 + 0.5*650 + 0.2*350 = 608

d. What is the expected value of perfect information?

EVPI = EVwPI – Evmax = 720 – 608 = 112