solution
A manager is considering the possibility of starting a new plant that will produce small sailboats for the recreational market. The boats will be of the highest quality and extremely stable. The sail size will also be reduced to prevent problems of overturning. The basic decision of the company is whether to build a large manufacturing facility, a small manufacturing facility, or no facility at all. With a favorable market, the company can expect to make $90,000 from the large facility or $60,000 from the smaller facility. If the market is unfavorable, however, the company estimates that it would lose $30,000 with a large facility, and it would lose only $20,000 with the small facility. Because of the expense involved in developing the initial molds and acquiring the necessary equipment to produce fiberglass sailboats, the company has decided to conduct a pilot study to make sure that the market for the sailboats will be adequate. The pilot study will cost $10,000 to the company. Furthermore, the pilot study can be either favorable or unfavorable. The company estimates that the probability of a favorable market given a favorable pilot study is 0.8. The probability of an unfavorable market given an unfavorable pilot study result is estimated to be 0.9. The company estimates that there is a 0.65 chance that the pilot study will be favorable.
Of course, the company could bypass the pilot study and simply make the decision as to whether to build a large plant, small plant, or no facility at all. Without doing any testing in a pilot study, the company estimates that the probability of a favorable market is 0.6.
Answer the following questions:
- Draw the decision tree for the above scenario.
- Identify the best strategy based on expected value approach.
- How many strategies the manager has?
- On the constructed decision tree, highlight the following three strategies for the above decision problem:
a. A strategy that involve conducting pilot study- Build a small facility.
b. A strategy that involve do not conduct pilot study – Don’t build a facility.
c. A strategy that involve do not conduct pilot study – Build a large facility. - Draw the risk profiles for the strategies identified in Part-4.
- Draw the cumulative risk profiles for the strategies identified in Part-4.
- Identify dominated strategies, and the corresponding type of dominance between every
pair of strategies identified in Part-4.
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