Reference no: EM13969887

Expected Value

GoSki Industries, Inc., wished to make a decision about whether to build a large or a small plant to produce a newly invented line of snowboards. The small plant will cost $2.8 million to build and put into operation. The large plant will cost $5.6 million to build and put into operation. The company's best estimate of sales over a planning horizon of 10 years is shown in the following table. GoSki's marketing department performed a cost/volume/profit analysis, which is shown in the following table.

Demand	Probability
High	5
Moderate	3
Low	2

GoSki's marketing department performed a cost/volume/profit analysis, which is shown in the following table:

Demand	Large Plant	Small Plant
High	$20,000,000	$ 5,000,000
Moderate	$12,000,000	$ 9,000,000
Low	$ -4,000,000	$11,000,000

Including the cost of construction, the payoff table looks like the following:

Demand	Large Plant	Small Plant
High	$14,400,000	$2,200,000
Moderate	$  6,400,000	$6.200,000
Low	$ -9,600,000	$8,200,000

QUESTIONS:

Create a decision tree which represents all of the outcomes. Assume the following:

• There are only two possible plant sizes, and once built the size is fixed.
• Demand is a discrete variable with only three possible values.
• The future consists of a single 10 year period with the time value of money is not a factor.

Calculate the expected value of having built a large plant.

Calculate the expected value of having built the small plant.

Given the results from these two calculations, which plant would you recommend that GoSki Industries build? Provide a rationale.