A company needs to increase its production beyond its existing capacity. It has narrowed the alternatives to two approaches to increase the production capacity:
(a) expansion, at a cost of $ 8 million, or
(b) modernization at a cost of $ 5 million.
Both approaches would require the same amount of time for implementation. Management believes that over the required payback period, demand will either be high or moderate.
Since high demand is considered to be somewhat less likely than moderate demand, the probability of high demand has been set at 0.35. If the demand is high, expansion would gross an estimated additional $ 12 million but modernization only an additional $ 6 million, due to lower maximum production capability. On the other hand, if the demand is moderate, the comparable figures would be $ 7 million for expansion and $ 5 million for modernization.
a) Calculate the conditional profit in relation to various action-and-outcome combinations and states of nature.
b) If the company wishes to maximize its expected monetary value (EMV), should it modernize or expand?
c) Calculate the EVPI.
d) Construct the conditional opportunity loss table and also calculate EOL.