Question

The product design group of lyengar 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 150,000 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 $40,000 and variable-cost probabilities of 0.2 for $0.59, 0.5 for $0.58, and 0.3 for $0.53. Subcontract a medium-cost approach using a good outside design staff. This approach would have a fixed cost of $55,000 and variable-cost probabilities of 0.6 of $0.53, 0.2 of $0.48, and 0.2 of $0.39 High-tech: a high-technology approach using the very best of the inside staff and the latest computer-aided design technology. This approach has probabilities of 0.8 of $0.35 and 0.2 of $0.28 fixed cost of $80,000 and variable-cost 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.) O High-tech O Subcontract OLow-tech

Answer 1

EMV of Low-tech = -40000-(.2*.59+.5*.58+.3*.53)*150000 = $ -125,050 (EMV if negative, because it is cost)

EMV of Subcontract = -55000-(.6*.53+.2*.48+.2*.39)*150000 = $ -128,800

EMV of High-tech = -80000-(.8*.35+.2*.28)*150000 = $ -130,400

EMV of Low-tech is the highest (least cost)

Therefore, best decision based on EMV criterion is:

Low-tech