The operations manager for a well-drilling company must recommend whether to build a new facility,expand his existing one,or do nothing.He estimates that long-run profits (in $000)will vary with the amount of precipitation (rainfall)as follows: If he feels the chances of low,normal,and high precipitation are 30%,20%,and 50%,respectively,what are expected long-run profits for the alternative he will select?

Question

The operations manager for a well-drilling company must recommend whether to build a new facility,expand his existing one,or do nothing.He estimates that long-run profits (in $000)will vary with the amount of precipitation (rainfall)as follows:  If he feels the chances of low,normal,and high precipitation are 30%,20%,and 50%,respectively,what are expected long-run profits for the alternative he will select?

Quizplus · Accepted Answer

To calculate the expected long-run profits, we need to take a weighted average of the profits under each scenario, based on the probability of that scenario occurring.

Expected long-run profits = (0.3 x 140) + (0.2 x 170) + (0.5 x 305) 
Expected long-run profits = 42 + 34 + 152.5 
Expected long-run profits = $228.5 million

Therefore, the best choice is to expand the existing facility, as it has the highest expected long-run profits.

The Operations Manager for a Well-Drilling Company Must Recommend Whether