Mark is considering opening a bookstore in a town center, and he has begun an analysis of the situation. There are two possible sites under consideration. One is relatively small, while the other is large.
If he opens at Site 1 (small site) and demand is high, he will generate a profit of $50,000.
If demand is low, he will lose $10,000.
If he opens at Site 2 (large site) and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if demand is low.
He also has the option of not opening at either site.
He believes that there is a 50 percent chance that demand will be high.
A market research study will cost $5,000.
The probability of a high demand given a favorable study is 0.8. The probability of a high demand given an unfavorable study is 0.1.
There is a 60 percent chance that the study will be favorable.
Use the following abbreviations shown in Blue:
Small site -- Site 1
Large site -- Site 2
No store -- Neither
High Demand -- HD
Low Demand -- LD
Favorable Study -- FS
Unfavorable Study -- US
(a) Draw the Decision Tree (show all options, payoffs, probabilities, EMVs).
NOTE: The main probabilities (including Bayes) are given; however, complementary probabilities must be computed. Show how you computed those probabilities.
(b) Should Mark use the study? Why?
(c) If the study is done and the results are favorable, what would Mark's expected profit be? Why?
(d) Compute the EVSI.