A firm must decide whether to construct a small, medium, or large stamping plant. A consultant’sreport indicates a .20 probability that demand will be low and an .80 probability that demand willbe high.If the firm builds a small facility and demand turns out to be low, the net present value will be$42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million.The firm could build a medium-size facility as a hedge: If demand turns out to be low, its netpresent value is estimated at $22 million; if demand turns out to be high, the firm could do nothingand realize a net present value of $46 million, or it could expand and realize a net present value of$50 million.If the firm builds a large facility and demand is low, the net present value will be – $20 million,whereas high demand will result in a net present value of $72 million.a. Analyze this problem using a decision tree.b. What is the maximin alternative?c. Compute the EVPI and interpret it.d. Perform sensitivity analysis on P(high)
A firm must decide whether to construct a small, medium, or large stamping plant. A consultant’s
report indicates a .20 probability that demand will be low and an .80 probability that demand will
be high.
If the firm builds a small facility and demand turns out to be low, the
$42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million.
The firm could build a medium-size facility as a hedge: If demand turns out to be low, its net
present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing
and realize a net present value of $46 million, or it could expand and realize a net present value of
$50 million.
If the firm builds a large facility and demand is low, the net present value will be – $20 million,
whereas high demand will result in a net present value of $72 million.
a. Analyze this problem using a decision tree.
b. What is the maximin alternative?
c. Compute the EVPI and interpret it.
d. Perform sensitivity analysis on P(high)
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