Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:
Equipment Favorable Market ($) Unfavorable Market ($)
Sub 100 300,000 -200,000
Oiler J 265,000 -96,000
Texas 85,000 -18,000
For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.
The Lubricant is an expensive oil newsletter to which many oil giants subscribe, including Ken Brown. In the last issue, the letter described how the demand for oil products would be extremely high. Apparently, the American consumer will continue to use oil products even if the price of these products doubles. Indeed, one of the articles in the Lubricant states that the chances of a favorable market for oil products was 75%, while the chance of an unfavorable market was only 25%. Ken would like to use these probabilities in determining the best decision.
(a) What decision model should be used?
(b) What is the optimal decision?
(c) Ken believes that the $300,000 figure for the Sub 100 with a favorable market is too high. How much lower would this figure have to be for Ken to change his decision made in part b?