Question

LSMU makes picture frames for fine art. Each frame generates revenue of $100. LSMU has estimated three possible levels of demand for frames in the coming year: there is a 50% chance the demand will be 600; a 30% chance the demand will be 800, and a 20% chance the demand will be 1,500.

a) LSMU currently has a capacity of 900 frames per year that limits how many they can produce and sell. What is the expected value of the revenue for next year for LSMU?

b) What capacity (in frames per year) for LSMU would be needed to make the expected value of revenue for next year be $80,000 forMU?

Answer 1

Given : Revenue from each frame = $100

Probability for 600 frames = 50%

Probability for 800 frames = 30%

Probability for 1500 frames = 20%; Since the capacity is 900 only, hence we have to consider probability for 900 frames as 20% instead of 1500 frames

We get EMV =

= (50% of 600 + 30% of 800 + 20% of 900) x $100

= $72,000

a. Hence, expected value of the revenue for next year for LSMU = $72,000

b. Since probabilities remain same, we have to increase capacity to get EMV of $80,000

Hence, we get

Expected EMV = (50% of 600 + 30% of 800 + 20% of capacity) x 100

80000 = (300 + 240+ 20% x Capacity) x 100

Solving, We get Capacity = 1300

b. To make the expected value of revenue for next year as $80,000, the capacity of production has to be 1300 frames per year