YourHome Construction Co. wants to get in on the boom of student condominium construction. The company must decide whether to purchase enough land to build a 100, 200, or 300 unit condominium complex. Many other complexes are currently under construction so YH is unsure how strong demand for its complex will be. If the company is conservative and builds only a few units, it loses potential profits if the demand is high. On the other hand, many unsold units would also be costly. The table below shows estimated profit (in $000) for the three options under different levels of demand. Low Demand Medium Demand High Demand Build 100 400 400 400 Build 200 100 800 800 Build 300 -200 500 1,200 Assume the following probabilities have been estimated: P(Low) = 0.25, P(Med) = 0.35, P(High) =0.4 Calculate the EMV for each alternative. What would you recommend to YourHome if the EMV was used? Calculate the EVwithPI and the EVof PI for this problem. How would you interpret the EVof PI?
YourHome Construction Co. wants to get in on the boom of student condominium construction. The company must decide whether to purchase enough land to build a 100, 200, or 300 unit condominium complex. Many other complexes are currently under construction so YH is unsure how strong demand for its complex will be. If the company is conservative and builds only a few units, it loses potential profits if the demand is high. On the other hand, many unsold units would also be costly. The table below shows estimated profit (in $000) for the three options under different levels of demand.
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Low Demand |
Medium Demand |
High Demand |
|
Build 100 |
400 |
400 |
400 |
|
Build 200 |
100 |
800 |
800 |
|
Build 300 |
-200 |
500 |
1,200 |
Assume the following probabilities have been estimated: P(Low) = 0.25, P(Med) = 0.35, P(High) =0.4
- Calculate the EMV for each alternative.
- What would you recommend to YourHome if the EMV was used?
- Calculate the EVwithPI and the EVof PI for this problem.
- How would you interpret the EVof PI?
- Western, Inc is considering adding to its product line with a brand new widget model. As in many new-product situations, there is considerable uncertainty about whether the new product will eventually “catch on.” Western believes that it might be prudent to introduce the product in a regional test market before introducing it nationwide.
Therefore, the company’s first decision is whether to conduct the regional test.
If the original decision is to not run the regional test, then the decision whether or not to market the product nationally can be made without further delay.
If a regional test is not done and they go ahead with the national market, the probability of getting a positive outcome is .45 with a net payoff of $16,500 and the probability of getting a negative outcome is .55 with a net loss of $5,500 (note a loss is a negative payoff).
If the regional test is not done and they do not go ahead with the product, the net payoff is 0.
If they decide to conduct the regional test, they must then wait for the test results and use the results to decide whether to market the product nationally or not.
If a regional test is done, the results are expected to be a great test with a probability of .65 or an awful test with a probability of 0.35. Regardless of test results, the decision must then be made to go ahead with the national market or not.
If they go ahead with a national market after a great test, the probability of a positive outcome is .70 with a net payoff of $16,000, the probability of a negative outcome is .30, with a net loss of $5,000.
If they decide to go ahead with a national market after an awful test, the probability of a positive outcome is .10, with a net payoff of $16,000, the probability of a negative outcome is .90, with a net loss of $5,000.
If they decide not to go ahead with the national market after the regional test, the net payoff will be a net loss of $500.
Draw a decision tree and solve it to determine the best course of action for Western.
Clearly write out your full recommendation on the worksheet with the tree
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