Company A faces the decision of buying a new flexible manufacturing system or keeping the current system. Management projections for the cash flows are given below under two demand scenarios: H (high demand) and L (low demand). This information is summarized in the following table.
H(0.5) L(0.5)
Old System $35M $17.5M
FMS $45M $13M
1. To compute the expected value of each alternative and the Expected value under perfect information.
Old System = 35*0.5 + 17.5*0.5 = 26.25
FMS = 45*0.5 + 13*0.5 = 29
Is this correct?
What is the maximum expected value of additional information?
2. Company A considering the advisability of undertaking a study, which will make a prediction on demand, at a cost of $2M. Company A's assessment of confidence in the study is summarized by the conditional probabilities of the prediction, h (high) or l(low), given the state of nature H or L. These probabilities are: P(h|H) = 0.7, P(h|L) =
0.2, P(l|H) = 0.3 and P(l|L) = 0.8.
Based on this info, how do I compute the posterior probabilities under each prediction, and determine if the study should be undertaken?