EMV APPLIED TO CAPACITY DECISION Southern Hospital Supplies, a company that makes hospital gowns, is considering capacity expansion.APPROACH: c Southern’s major alternatives are to do nothing, build a small plant, build a medium plant, or build a large plant. The new facility would produce a new type of gown, and currently the po-tential or marketability for this product is unknown. If a large plant is built and a favorable market ex-ists, a profit of $100,000 could be realized. An unfavorable market would yield a $90,000 loss. However, a medium plant would earn a $60,000 profit with a favorable market. A $10,000 loss would result froman unfavorable market. A small plant, on the other hand, would return $40,000 with favorable marketconditions and lose only $5,000 in an unfavorable market. Of course, there is always the option of doingnothing.Recent market research indicates that there is a .4 probability of a favorable market, which meansthat there is also a .6 probability of an unfavorable market. With this information, the alternative thatwill result in the highest expected monetary value (EMV) can be selected.
Compound Probability
Compound probability can be defined as the probability of the two events which are independent. It can be defined as the multiplication of the probability of two events that are not dependent.
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Probability theory is a branch of mathematics that deals with the subject of probability. Although there are many different concepts of probability, probability theory expresses the definition mathematically through a series of axioms. Usually, these axioms express probability in terms of a probability space, which assigns a measure with values ranging from 0 to 1 to a set of outcomes known as the sample space. An event is a subset of these outcomes that is described.
Conditional Probability
By definition, the term probability is expressed as a part of mathematics where the chance of an event that may either occur or not is evaluated and expressed in numerical terms. The range of the value within which probability can be expressed is between 0 and 1. The higher the chance of an event occurring, the closer is its value to be 1. If the probability of an event is 1, it means that the event will happen under all considered circumstances. Similarly, if the probability is exactly 0, then no matter the situation, the event will never occur.
EMV APPLIED TO CAPACITY DECISION
Southern Hospital Supplies, a company that makes hospital gowns, is considering capacity expansion.
APPROACH: c Southern’s major alternatives are to do nothing, build a small plant, build a medium
plant, or build a large plant. The new facility would produce a new type of gown, and currently the po-
tential or marketability for this product is unknown. If a large plant is built and a favorable market ex-
ists, a profit of $100,000 could be realized. An unfavorable market would yield a $90,000 loss. However,
a medium plant would earn a $60,000 profit with a favorable market. A $10,000 loss would result from
an unfavorable market. A small plant, on the other hand, would return $40,000 with favorable market
conditions and lose only $5,000 in an unfavorable market. Of course, there is always the option of doing
nothing.
Recent
that there is also a .6 probability of an unfavorable market. With this information, the alternative that
will result in the highest expected monetary value (EMV) can be selected.
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