Concept explainers
To determine: How to select the best decision based on Expected Monetary Value (EMV) criterion.
Introduction: Expected Monetary Value (EMV) is a system for calculating expected returns for certain decision made by a company.
Answer to Problem 18P
The low-technology approach can be selected with a cost of $145,000.
Explanation of Solution
Given information:
Strategies used:
| Low-tech | ||
| Fixed cost | Probability | Variable cost |
| $45,000.00 | 0.3 | $0.55 |
| 0.4 | $0.50 | |
| 0.3 | $0.45 | |
| Sub-contract | ||
| Fixed cost | Probability | Variable cost |
| $65,000.00 | 0.7 | $0.45 |
| 0.2 | $0.40 | |
| 0.1 | $0.35 | |
| High-tech | ||
| Fixed cost | Probability | Variable cost |
| $75,000.00 | 0.9 | $0.40 |
| 0.1 | $0.35 | |
| 0 | $0.00 | |
| Market forecast | 200,000 | Total | |
| Low-tech | |||
| Fixed cost | Probability | Variable cost | |
| $45,000.00 | 0.3 | $0.55 | $155,000.00 |
| 0.4 | $0.50 | $145,000.00 | |
| 0.3 | $0.45 | $135,000.00 | |
| Sub-contract | Total | ||
| Fixed cost | Probability | Variable cost | |
| $65,000.00 | 0.7 | $0.45 | $155,000.00 |
| 0.2 | $0.40 | $145,000.00 | |
| 0.1 | $0.35 | $135,000.00 | |
| High-tech | Total | ||
| Fixed cost | Probability | Variable cost | |
| $75,000.00 | 0.9 | $0.40 | $155,000.00 |
| 0.1 | $0.35 | $145,000.00 | |
| 0 | $0.00 | $0.00 | |
Calculation of total cost:
Low technology:
- Probability 0.3
With a probability of 0.3, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.55. The product is added with the fixed cost, which is $45,000. The resultant total cost is $155,000.
- Probability 0.4
With a probability of 0.4, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.50. The product is added with the fixed cost, which is $45,000. The resultant total cost is $145,000.
- Probability 0.3
With a probability of 0.3, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.45. The product is added with the fixed cost, which is $45,000. The resultant total cost is $135,000.
Sub-contract:
- Probability 0.7
With a probability of 0.7, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.45. The product is added with the fixed cost, which is $65,000. The resultant total cost is $155,000.
- Probability 0.2
With a probability of 0.2, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.40. The product is added with the fixed cost which is $65,000. The resultant total cost is $145,000.
- Probability 0.1
With a probability of 0.1, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.35. The product is added with the fixed cost which is $65,000. The resultant total cost is $135,000.
High-tech:
- Probability 0.9
With a probability of 0.9, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.40. The product is added with the fixed cost which is $75,000. The resultant total cost is $155,000.
- Probability 0.1
With a probability of 0.1, the variable cost is calculated by multiplying the total market forecast of 200,000 with the variable cost $0.35. The product is added with the fixed cost which is $75,000. The resultant total cost is $145,000.
Hence, from the above calculations, it can be inferred that market forecast for low-technology (which consists of hiring several new junior engineers)at the cost of $145,000 can be selected.
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