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S1.16/The Willow Café is located in an open-air mall. Its lease expires this year and the restaurant owner has the option of signing a 1-, 2-, 3-, 4-, or 5-year lease. However, the owner is concerned about recent energy price increases (including the price of gasoline), which affect virtually every aspect of the restaurant operation, including the price of food items and materials, delivery costs, and its own utilities. The restaurant was very profitable when energy prices were lower, and the owner believes if prices remain at approximately their cur- rent level profits will still be satisfactory; however, if prices continue to rise he believes that he might be forced to close. In these latter circumstances a longer-term lease could be a financial disaster, but with a shorter-term lease the mall landlord could always rent the restaurant's space out from under it when the lease expires. Thus, the restaurant owner's estimates of future profits must also reflect the possibility that the lease will not be renewable. The following pay- off table summarizes the owner's profit (and loss) estimates for each future state of nature of energy prices (over a five-year period): Energy Prices Lease Decrease Same Increase Decision .17 .34 .49 1-year $156,000 $93,000 $16,000 2-year 427,000 150,000 -42,000 3-year 642,000 319,000 -171,000 4-year 933,000 473,000 -337,000 5-year 1,228,000 516,000 -551,000 a. Determine the best decision using expected value. b. Compute the expected value of perfect information for the Willow Café. Explain what this value means and how such infor- mation might be obtained.

S1.16/The Willow Café is located in an open-air mall. Its lease expires this year and the restaurant owner has the option of signing a 1-, 2-, 3-, 4-, or 5-year lease. However, the owner is concerned about recent energy price increases (including the price of gasoline), which affect virtually every aspect of the restaurant operation, including the price of food items and materials, delivery costs, and its own utilities. The restaurant was very profitable when energy prices were lower, and the owner believes if prices remain at approximately their cur- rent level profits will still be satisfactory; however, if prices continue to rise he believes that he might be forced to close. In these latter circumstances a longer-term lease could be a financial disaster, but with a shorter-term lease the mall landlord could always rent the restaurant's space out from under it when the lease expires. Thus, the restaurant owner's estimates of future profits must also reflect the possibility that the lease will not be renewable. The following pay- off table summarizes the owner's profit (and loss) estimates for each future state of nature of energy prices (over a five-year period): Energy Prices Lease Decrease Same Increase Decision .17 .34 .49 1-year $156,000 $93,000 $16,000 2-year 427,000 150,000 -42,000 3-year 642,000 319,000 -171,000 4-year 933,000 473,000 -337,000 5-year 1,228,000 516,000 -551,000 a. Determine the best decision using expected value. b. Compute the expected value of perfect information for the Willow Café. Explain what this value means and how such infor- mation might be obtained.

Practical Management Science
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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S1.16/The Willow Café is located in an open-air mall. Its lease expires this year and the restaurant owner has the option of signing a 1-, 2-, 3-, 4-, or 5-year lease. However, the owner is concerned about recent energy price increases (including the price of gasoline), which affect virtually every aspect of the restaurant operation, including the price of food items and materials, delivery costs, and its own utilities. The restaurant was very profitable when energy prices were lower, and the owner believes if prices remain at approximately their cur- rent level profits will still be satisfactory; however, if prices continue to rise he believes that he might be forced to close. In these latter circumstances a longer-term lease could be a financial disaster, but with a shorter-term lease the mall landlord could always rent the restaurant's space out from under it when the lease expires. Thus, the restaurant owner's estimates of future profits must also reflect the possibility that the lease will not be renewable. The following pay- off table summarizes the owner's profit (and loss) estimates for each future state of nature of energy prices (over a five-year period): Energy Prices Lease Decrease Same Increase Decision .17 .34 .49 1-year $156,000 $93,000 $16,000 2-year 427,000 150,000 -42,000 3-year 642,000 319,000 -171,000 4-year 933,000 473,000 -337,000 5-year 1,228,000 516,000 -551,000 a. Determine the best decision using expected value. b. Compute the expected value Willow Café. Explain what this value means and how such infor- perfect information for the mation might be obtained.
Transcribed Image Text:S1.16/The Willow Café is located in an open-air mall. Its lease expires this year and the restaurant owner has the option of signing a 1-, 2-, 3-, 4-, or 5-year lease. However, the owner is concerned about recent energy price increases (including the price of gasoline), which affect virtually every aspect of the restaurant operation, including the price of food items and materials, delivery costs, and its own utilities. The restaurant was very profitable when energy prices were lower, and the owner believes if prices remain at approximately their cur- rent level profits will still be satisfactory; however, if prices continue to rise he believes that he might be forced to close. In these latter circumstances a longer-term lease could be a financial disaster, but with a shorter-term lease the mall landlord could always rent the restaurant's space out from under it when the lease expires. Thus, the restaurant owner's estimates of future profits must also reflect the possibility that the lease will not be renewable. The following pay- off table summarizes the owner's profit (and loss) estimates for each future state of nature of energy prices (over a five-year period): Energy Prices Lease Decrease Same Increase Decision .17 .34 .49 1-year $156,000 $93,000 $16,000 2-year 427,000 150,000 -42,000 3-year 642,000 319,000 -171,000 4-year 933,000 473,000 -337,000 5-year 1,228,000 516,000 -551,000 a. Determine the best decision using expected value. b. Compute the expected value Willow Café. Explain what this value means and how such infor- perfect information for the mation might be obtained.
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