A Town Council has decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area, but the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst case, base case, and best case. The worst-case scenario corresponds to a situation in which tourism drops significantly; the base-case scenario corresponds to a situation in which the town continues to attract visitors at current levels; and the best-case scenario corresponds to a significant increase in tourism. The consultant has provided probability assessments of 0.10, 0.60, and 0.30 for the worst-case, base-case, and best-case scenarios, respectively. The town council suggested using net cash flow over a five-year planning horizon as the criterion for deciding on the best size. A consultant developed the following projections of net cash flow (in thousands of dollars) for a five-year planning horizon. All costs, including the consultant's fee, are included. Center Size Demand Scenario Worst Case Base Case Best Case Small 390 490 650 Medium −260 640 790 Large −410 570 980 (a) What decision should the town make using the expected value approach? EV(Small)528 EV(Medium)595 EV(Large)595 The best decision is to build a medium or large-sized community center. (b) Compute the expected value of perfect information. EVPI = 588.3 Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur? The town should consider additional information about the likelihood of the three scenarios.The town should not consider additional information about the likelihood of the three scenarios. (c) Suppose the probability of the worst-case scenario increases to 0.2, the probability of the base-case scenario decreases to 0.5, and the probability of the best-case scenario remains at 0.3. EV(Small)518 EV(Medium)505 EV(Large)497 What effect, if any, would these changes have on the decision recommendation? The best decision is to build a small community center. (d) The consultant suggested that an expenditure of $150,000 on a promotional campaign over the planning horizon will effectively reduce the probability of the worst-case scenario to zero. The campaign can be expected to also increase the probability of the best-case scenario to 0.4. (Remember to subtract the cost of the promotional campaign from the expected value.) EV(Small)554 EV(Medium)700 EV(Large)734 The best decision is to build a large community center. Compared to the analysis in part (c), is this a good investment? It is not a good investment as the risk of loss is not eliminated.It is not a good investment as the risk of loss is eliminated. It is a good investment as the risk of loss is not eliminated.It is a good investment as the risk of loss is eliminated.

A Town Council has decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area, but the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst case, base case, and best case. The worst-case scenario corresponds to a situation in which tourism drops significantly; the base-case scenario corresponds to a situation in which the town continues to attract visitors at current levels; and the best-case scenario corresponds to a significant increase in tourism. The consultant has provided probability assessments of 0.10, 0.60, and 0.30 for the worst-case, base-case, and best-case scenarios, respectively. The town council suggested using net cash flow over a five-year planning horizon as the criterion for deciding on the best size. A consultant developed the following projections of net cash flow (in thousands of dollars) for a five-year planning horizon. All costs, including the consultant's fee, are included. Center Size Demand Scenario Worst Case Base Case Best Case Small 390 490 650 Medium −260 640 790 Large −410 570 980 (a) What decision should the town make using the expected value approach? EV(Small)528 EV(Medium)595 EV(Large)595 The best decision is to build a medium or large-sized community center. (b) Compute the expected value of perfect information. EVPI = 588.3 Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur? The town should consider additional information about the likelihood of the three scenarios.The town should not consider additional information about the likelihood of the three scenarios. (c) Suppose the probability of the worst-case scenario increases to 0.2, the probability of the base-case scenario decreases to 0.5, and the probability of the best-case scenario remains at 0.3. EV(Small)518 EV(Medium)505 EV(Large)497 What effect, if any, would these changes have on the decision recommendation? The best decision is to build a small community center. (d) The consultant suggested that an expenditure of $150,000 on a promotional campaign over the planning horizon will effectively reduce the probability of the worst-case scenario to zero. The campaign can be expected to also increase the probability of the best-case scenario to 0.4. (Remember to subtract the cost of the promotional campaign from the expected value.) EV(Small)554 EV(Medium)700 EV(Large)734 The best decision is to build a large community center. Compared to the analysis in part (c), is this a good investment? It is not a good investment as the risk of loss is not eliminated.It is not a good investment as the risk of loss is eliminated. It is a good investment as the risk of loss is not eliminated.It is a good investment as the risk of loss is eliminated.

Practical Management Science

6th Edition

ISBN:9781337406659

Author:WINSTON, Wayne L.

Publisher:WINSTON, Wayne L.

Chapter2: Introduction To Spreadsheet Modeling

Section: Chapter Questions

Problem 20P: Julie James is opening a lemonade stand. She believes the fixed cost per week of running the stand...

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Question

The town council suggested using net cash flow over a five-year planning horizon as the criterion for deciding on the best size. A consultant developed the following projections of net cash flow (in thousands of dollars) for a five-year planning horizon. All costs, including the consultant's fee, are included.

Center Size	Demand Scenario
Worst Case	Base Case	Best Case
Small	390	490	650
Medium	−260	640	790
Large	−410	570	980

(a)

What decision should the town make using the expected value approach?

EV(Small)528 EV(Medium)595 EV(Large)595 The best decision is to build a medium or large-sized community center.

(b)

Compute the expected value of perfect information.

EVPI = 588.3

Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur?

The town should consider additional information about the likelihood of the three scenarios.The town should not consider additional information about the likelihood of the three scenarios.

(c)

Suppose the probability of the worst-case scenario increases to 0.2, the probability of the base-case scenario decreases to 0.5, and the probability of the best-case scenario remains at 0.3.

EV(Small)518 EV(Medium)505 EV(Large)497

What effect, if any, would these changes have on the decision recommendation?

The best decision is to build a small community center.

(d)

The consultant suggested that an expenditure of $150,000 on a promotional campaign over the planning horizon will effectively reduce the probability of the worst-case scenario to zero. The campaign can be expected to also increase the probability of the best-case scenario to 0.4. (Remember to subtract the cost of the promotional campaign from the expected value.)

EV(Small)554 EV(Medium)700 EV(Large)734 The best decision is to build a large community center.

Compared to the analysis in part (c), is this a good investment?

It is not a good investment as the risk of loss is not eliminated.It is not a good investment as the risk of loss is eliminated. It is a good investment as the risk of loss is not eliminated.It is a good investment as the risk of loss is eliminated.

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