Question:
Spencerville Products is expanding its operations west of the Mississippi. Its first step is to build a manufacturing facility in Denver to satisfy demand on the West Coast. Spencerville has an option to build either a large facility that has an annual output of 500,000 units per year or a smaller facility with an output of 250,000 units per year. It must build one of these two facilities - it does not have any other options.
The expected demand for the company's products is shown as either high or moderate in the table below:
Demand Level Annual Demand (units/year) Probability
High 450,000 0.4
Moderate 150,000 0.6
The small facility has a profit of $5.00 per unit. The large facility has a profit of $4.00/unit.
a) What size facility should Spencerville Products build based on expected values and using a decision tree approach? You must also provide the decision tree using the appropriate decision tree symbols.
b) Suppose that the company is not certain about the 450,000 projection for the High Demand scenario. It could be higher than this projection. How sensitive is the selection in a) to the High Demand projection. In other words, at what annual demand for the High Demand scenario would the company be indifferent between the two size facilities?