A firm that plans to expand its product line must decide whether to build a small or large facility to produce the new products. If it builds a small facility and demand is lower, the net present value after deducting for building costs will be $400,000. If demand is high, the firm can either maintain the small facility or expand it. Expansion would have a net present valueof $450,000, and maintaining the small facility would have a net present value of $50,000. If a large facility is built and demand is high, the estimated net present value is $800,000. If demand turns out to be low, the net present value will be -$10,000. The probability that demand is high is estimated to be 0.60, and the probability of low demand is estimated to be 0.40.
a. Analyze using a tree diagram.
b. Compute the EVPI. How could this information be used?
c. Determine the range over which each alternative would be best in terms of the value of P (demand low).