Question

A small parts manufacturer has just engineered a new product for the automotive industry. In order to produce the part the company can expand existing facilities, acquire a competitor, or subcontract production. The company believes the product will either experience high market demand or low market demand. The company believes the product will either experience high market demand or low market demand, with probabilities of 0.55 and 0.45, respectively.
The following payoff table describes the company’s decision situation (all numbers are in thousands). Note that some numbers are negative.

--	High Demand	Low Demand
Expand	1800	-1250
Acquire	900	-425
Subcontract	250	35

•         What is the best decision based on optimistic approach? (Expand/Acquire/Subcontract)
•         What is the best decision based on pessimistic approach? (Expand/Acquire/Subcontract)
•         What is the best decision based on equal likelihood approach? (Expand/Acquire/Subcontract)
•         Fill in the following blanks. Keep two decimal places for your calculations.

--	Average (for equal likelihood)
Expand
Acquire
Subcontract

Answer 1

Optimistic

Compute the maximum payoff for each alternative and then select the alternative which gives maximum out of these maximums.

	High Demand	Low Demand	Max Payoff
Expand	1800	-1250	1800
Acquire	900	-425	900
Subcontract	250	35	250

So, the best decision is 'Expand'.

Pessimistic

Compute the minimum payoff for each alternative and then select the alternative which gives maximum out of these minimums.

	High Demand	Low Demand	Min Payoff
Expand	1800	-1250	-1250
Acquire	900	-425	-425
Subcontract	250	35	35

So, the best decision is 'Subcontract'.

Equally likely

Compute the average payoff for each alternative and then select the alternative which gives maximum out of these averages.

	High Demand	Low Demand	Avg. Payoff
Expand	1800	-1250	275.0
Acquire	900	-425	237.5
Subcontract	250	35	142.5

So, the best decision is 'Expand'.

--	Average in 1000 (for equal likelihood)
Expand	275.00
Acquire	237.50
Subcontract	142.50