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

According to the expected value criterion, we need to calculate the expected payoff for each decision alternative.
- If the company expands facilities:
      - If high demand: ($600,000 x 0.6) + ($200,000 x 0.4) = $440,000
      - If low demand: ($400,000 x 0.6) + ($100,000 x 0.4) = $280,000
- If the company acquires competitor:
      - If high demand: ($800,000 x 0.6) + ($200,000 x 0.4) = $560,000
      - If low demand: (-$300,000 x 0.6) + ($100,000 x 0.4) = -$100,000
- If the company subscontracts production:
      - If high demand: ($400,000 x 0.6) + ($200,000 x 0.4) = $320,000
      - If low demand: ($100,000 x 0.6) + ($0 x 0.4) = $60,000

Based on the expected payoffs, expanding facilities has the highest expected payoff of $440,000, so the best decision is to expand facilities.

A Small Parts Manufacturer Has Just Engineered a New Product