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Practice Problems: Module A, Decision Making Problem 1

1) Bascomb's Candy is considering introducing a new product line which would require either a major or minor renovation of their plant. The market could be favorable or unfavorable. They can also choose to not develop the new line. 2) With major renovation, a favorable market yields $100,000 while an unfavorable market loses $90,000. Minor renovation yields $40,000 and -$20,000 respectively, assuming both markets are equally likely. 3) Jeff Heyl should get more market research before deciding, which would cost an unknown amount. The Expected Value of Perfect Information is $40,000, since perfect information would yield $50,000 compared to $

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Practice Problems: Module A, Decision Making Problem 1

1) Bascomb's Candy is considering introducing a new product line which would require either a major or minor renovation of their plant. The market could be favorable or unfavorable. They can also choose to not develop the new line. 2) With major renovation, a favorable market yields $100,000 while an unfavorable market loses $90,000. Minor renovation yields $40,000 and -$20,000 respectively, assuming both markets are equally likely. 3) Jeff Heyl should get more market research before deciding, which would cost an unknown amount. The Expected Value of Perfect Information is $40,000, since perfect information would yield $50,000 compared to $

Uploaded by

anon_2139178
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Practice Problems: Module A, Decision Making

Problem 1:
Bascomb’s Candy is considering the introduction of a new line of products. In order to produce the
new line, the bakery is considering either a major or minor renovation of the current plant. The
market for the new line of products could be either favorable or unfavorable. Bascomb’s Candy has
the option of not developing the new product line at all. Develop the appropriate decision tree.

Problem 2:
With major renovation, at Bascomb’s Candy (See Problem 1 above) the payoff from a favorable
market is $100,000, from an unfavorable market $  90,000 . Minor renovations and favorable
market has a payoff of $40,000 and an unfavorable market $  20,000 . Assuming that a favorable
market and an unfavorable market are equally likely, solve the decision tree.

Problem 3:
Jeff Heyl, the owner of Bascomb’s Candy (Problem 1 and 2 above) realizes that he should get more
information before making his final decision. He decides to contract with a market research firm to
conduct a market survey. How much should Jeff be willing to pay for accurate information (i.e.
What is the Expected Value of Perfect Information, EVPI?)?

1
ANSWERS

Problem 1:

Problem 2:

Therefore, the appropriate choice under equally likely market conditions is to make the minor
modifications ( EMV  $10,000.)

2
Problem 3:
With knowledge of when a favorable market will occur, Jeff’s best payoff is major renovation. This
happens 1 2 the time. $100,000 * .5  $50,000

When unfavorable market exists, Jeff will do nothing, which happens 1


2 the time.
0 * .5 = $0.0
so Perfect Information yields  ($100,000 * .5)  (0 * .5)  $50,000

Therefore EMV is $10,000 vs. $50,000 with Perfect Information


and EVPI  $50,000  $10,000  $40,000

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