Question

Phillip Witt, president of Witt Input Devices, wishes to create a portfolio of local suppliers for his new line of keyboards. As the suppliers all reside in a location prone to hurricanes, tornadoes, flooding, and earthquakes, Phillip believes that the probability in any year of a "super-event" that might shut down all suppliers at the same time at least 2 weeks is 2%. Such a total shutdown would cost the company approximately $520,000. He estimates the "unique-event" risk for any of the suppliers to be 7% Assuming that the marginal cost of managing an additional supplier is $14,800 per year, how many suppliers should Witt Input Devices use? Assume that up to three nearly identical local suppliers are available. Find the EMV for alternatives using 1, 2, or 3 suppliers.

a) EMV(1) = $___

b) EMV(2) =$ ___

c) EMV(3) = $____

d) Which is the best choice?

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Answer 1

Super event risk, S = 2%

Unique event risk U = 7%

Marginal cost of managing supplier, C = 14,800

Loss in case of total shutdown, L = 520,000

EMV(n) = (S + (1-S)*U^n)*L + nC

EMV(1) = (0.02 + (1-0.02)*0.07^1)*520000 + 1*14800 = $ 60872

EMV(2) = (0.02 + (1-0.02)*0.07^2)*520000 + 2*14800 = $ 42497.04

EMV(3) = (0.02 + (1-0.02)*0.07^3)*520000 + 3*14800 = $ 54974.79

Using 2 supplier will be best choice.