Question

The product design group of Iyengar Electric​ Supplies, Inc., has determined that it needs to design a new series of switches. It must decide on one of three design strategies. The market forecast is for

300 comma 000300,000

units. The better and more sophisticated the design strategy and the more time spent on value​ engineering, the less will be the variable cost. The chief of engineering​ design, Dr. W. L.​ Berry, has decided that the following costs are a good estimate of the initial and variable costs connected with each of the three strategies explained below.

​Low-tech​:

a​ low-technology, low-cost process consisting of hiring several new junior engineers. This option has a fixed cost of

​$55 comma 00055,000

and​ variable-cost probabilities of

0.50.5

for

​$0.620.62​,

0.10.1

for

​$0.590.59​,

and

0.40.4

for

​$0.540.54.

Subcontract​:

a​ medium-cost approach using a good outside design staff. This approach would have a fixed cost of

​$65 comma 00065,000

and​ variable-cost probabilities of

0.70.7

of

​$0.460.46​,

0.20.2

of

​$0.430.43​,

and

0.10.1

of

​$0.420.42.

​High-tech​:

a​ high-technology approach using the very best of the inside staff and the latest​ computer-aided design technology. This approach has a fixed cost of

​$75 comma 00075,000

and​ variable-cost probabilities of

0.80.8

of

​$0.390.39

and

0.20.2

of

​$0.310.31.

What is the best decision based on an expected monetary value​ (EMV) criterion?

​(Note​:

We want the lowest​ EMV, as we are dealing with costs in this​ problem.)

Answer 1

Calculation of Expected Monetary Value of the three design options
Low Tech
Given the market forecast is 300000 units
50% probab of variable cost being $.62 prob of 10% of variable cost being $.59 and prob of 40% of variable cost being $.54
Expected Variable Cost
300000*((.50*$.62)+(.10*$.59)+(.40*$.54))
300000*.585
$175,500
Total Cost	Fixed Cost +Variable Cost
	$55000+$175500
	$230,500
The expected monetary value is $230500
Subcontract
Calculation of the expected variable cost with the market forecast of 300000 units
Probab of 70% variable cost being $.46 probab of 20% variable cost $.43 and prob of 10% with variable cost of $.42
Expected Variable Cost
	300000*(70%*.46+20%*.43+10%*.42)
Total Cost	Fixed Cost +Variable Cost
	$65000+$135000
	$200,000
The expected monetary value is $200000
High Tech
Calculation of the expected variable cost with the market forecast of 300000 units
Prob of 80% with variable cost of $.39 prob of 20% with variable cost of $.31
Expected Variable Cost	300000*(80%*.39+20%*.31)
	$112,200
Total Cost	Fixed Cost +Variable Cost
	$75000+$112200
	$187,200
Based on the lowest EMV we find that the lowest cost is in the case of High Tech which is having $187200