Question

A plant manager wants to know how much he should be willing to pay for perfect market research. Currently there are two states of nature facing his decision to expand or do nothing. Under favorable market conditions the manager would make $100,000 for the large plant and $5,000 for the small plant. Under unfavorable market conditions the large plant would lose $50,000 and the small plant would make $0. If the two states of nature are equally likely, how much should he pay for perfect information?

Answer 1

$25,000

Step-by-step explanation:

Decision pay off matrix

Plant Favourable market Unfavourable market equally likely

Large 100,000 (50,000) 25,000

Small 5000 0 2500

EVPI =?

EVPI = EVwPI - EVwoPI

EVPI = 50,000 - 25,000

EVPI = $25000

Workings

EVPI = Expected value of Perfect Information

EVwPI = Expected value with Perfect Information

EVwoPI = Expected value without Perfect Information

EVwPI = (100,000+0)/2

EVwPI = 50,000

EVwoPI = 25,000 equally likely