Question

This question refers to an example in the book Production/Operations Management by William J. Stevenson. The example involves a capacity-planning problem in which a company must choose to build a small, medium, or large production facility. The payoff obtained will depend on whether future demand is low, moderate, or high, and the payoffs are as given in the following table: Alternatives Small facility Medium facility Large facility Possible Future Demand Low Moderate High $11 $11 $11 8 13 13 -$5 1 15 *Present value in $ millions. Suppose that the company assigns prior probabilities of.3,.5, and 2 to low, moderate, and high demands, respectively. (a) Find the expected monetary value for each alternative (small, medium, and large). (Round your answers to 1 decimal place. Enter your answers in millions.) Maximum payoff for each alternative: EMV(Small) IM EMV(Medium) M EMV(Large) M (b) What is the best alternative if we use the expected monetary value criterion? Best alternative: Medium facility

Answer 1

a)

EM(small ) =11*0.3+11*0.5+11*0.2 =11 M

EM(medium) =8*0.3+13*0.5+13*0.2 =11.5 M

EM(large) =-5*0.3+1*0.5+15*0.2 =2 M

b)

Medium Facility