Question

Hudson Corporation is considering three options for managing its data warehouse: continuing with its own staff, hiring an outside vendor to do the managing (referred to as outsourcing), or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows:

Demand
  
Staffing Options High Medium Low
Own staff 650 650 600
Outside vendor 900 600 300
Combination 800 650 500
        
Required:
a. If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data processing operation?
b. Construct a risk profile for the optimal decision in part (a).

Answer 1

Step-by-step explanation:

a. If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data processing operation?

Expected value own staff = 0.2(650 + 0.5(650) + 0.3(300) = 635

EV outside vendor = 0.2(900) + 0.5(600) + 0.3(300) = 570

EV combination = 0.2(800) + 0.5(650) + 0.3(500) = 635

Therefore, the correct answer is outside vendor since it has the minimum expected value.

b. Construct a risk profile for the optimal decision in part (a)

Demand Cost Probability

Low. 300000. 0.3

Medium. 600000. 0.5

High 900000. 0.2

The required probability is 0.2