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, with probabilities of 0.6 and 0.4, respectively. The following payoff table describes the company's decision situation. The best decision according to the expected value criterion is
A) Acquire Competitor.
B) Expand Facilities.
C) Subcontract Production.
D) High Demand

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, with probabilities of 0.6 and 0.4, respectively. The following payoff table describes the company's decision situation.  The best decision according to the expected value criterion is
A) Acquire Competitor. 
B) Expand Facilities. 
C) Subcontract Production. 
D) High Demand

Quizplus · Accepted Answer

To determine the best decision according to the expected value criterion, we first need to calculate the expected values for each decision alternative.

Expected value for Expand Facilities: 
(0.6 x $600,000) + (0.4 x $100,000) = $420,000

Expected value for Acquire Competitor: 
(0.6 x $750,000) + (0.4 x $0) = $450,000

Expected value for Subcontract Production: 
(0.6 x $300,000) + (0.4 x $500,000) = $360,000

Expected value for High Demand: 
(0.6 x $1,200,000) + (0.4 x $800,000) = $1,080,000

The best decision according to the expected value criterion is the one with the highest expected value, which is Acquire Competitor. However, it is important to note that this decision is not always the best one, as it only considers the probabilities and payoffs without taking into account any other factors such as risk or ethics.

A Small Parts Manufacturer Has Just Engineered a New Product