Question

The J.R. Ryland Computer Company is considering a plant expansion to enable the company to begin production of a new computer product. The company’s president must determine whether to make the expansion a medium- or large-scale project. Demand for the new product is uncertain, which for planning purposes may be low demand, medium demand, or high demand. The probability estimates for demand are 0.20, 0.20, and 0.60, respectively. Letting x and y indicate the annual profit in thousands of dollars, the firm’s planners developed the following profit forecasts for the medium- and large-scale expansion projects.

Medium-Scale Large-Scale
Expansion Profit Expansion Profit
x f(x) y f(y)
Low 50 0.2 0 0.2
Demand Medium 150 0.5 100 0.5
High 200 0.3 300 0.3
​a. Compute the expected value for the profit associated with the two expansion alternatives.
Which decision is preferred for the objective of maximizing the expected profit?
b. Compute the variance for the profit associated with the two expansion alternatives.
Which decision is preferred for the objective of minimizing the risk or uncertainty?

Answer 1

Kindly check explanation

Explanation:

Given the data:

Medium-Scale Large-Scale

Expansion Profit Expansion Profit

x f(x) y f(y)

Low 50 0.2 0 0.2

Demand Medium 150 0.5 100 0.5

High 200 0.3 300 0.3

a. Compute the expected value for the profit associated with the two expansion alternatives.

Which decision is preferred for the objective of maximizing the expected profit?

Expected value for medium scale expansion profit :

Expected value (E) = Σ(X) * f(x)

Σ[(50 * 0.2) + (150 * 0.5) + (200 * 0.3)]

= 145

Expected value for Large scale expansion profit :

Expected value (E) = Σ(X) * f(x)

Σ[(0 * 0.2) + (100 * 0.5) + (300 * 0.3)]

= 140

Medium scale expansion profit is preferred as it has the highest expected value.

b. Compute the variance for the profit associated with the two expansion alternatives.

Which decision is preferred for the objective of minimizing the risk or uncertainty?

Variance (V) = Σ(X - E)² * f(x):

Variance for medium scale expansion profit :

V = [((50-145)^2 * 0.2) + ((150-145)^2 * 0.5) + ((200-145)^2 * 0.3) = 2725

Variance for Large scale expansion profit :

V = [((0-140)^2 * 0.2) + ((100-140)^2 * 0.5) + ((300-140)^2 * 0.3) = 12400

Smaller variance is required to minimize risk, Hence, choose the medium scale expansion profit.