Reference no: EM131226461

AllCotton textiles has contracted to provide HappyKart clothing retail with T-shirts under the following terms: (1) 100,000 T-shirts will be delivered to HappyKart in one month, and (2) HappyKart has an option to take delivery of an additional 100,000 T-shirts in three months by giving AllCotton 30 days notice. HappyKart will pay $5.00 for each T-shirt that it purchases. AllCotton manufactures the T-shirts using a batch process, and manufacturing costs are as follows: (1) there is a fixed setup cost of $250,000 for any manufacturing batch run, regardless of the size of the run,and (2) there is a marginal manufacturing cost of $2.00 per T-shirt regardless of the size of the batch run. AllCotton must decide whether to manufacture all 200,000 T-shirts now or whether to only manufacture 100,000 now and manufacture the other 100,000 T-shirts only if HappyKart exercises its option to buy those T-shirts. If AllCotton manufactures 200,000 now and HappyKart does not exercise its option, then the manufacturing cost of the extra 100,000 T-shirts will be totally lost. AllCotton believes there is a 50% chance HappyKart will exercise its option to buy the additional 100,000 T-shirts.

(i) Draw a decision tree for the decision that AllCotton faces.

(ii) Determine the preferred course of action for AllCotton assuming it uses expected profit as its decision criterion.

(iii) AllCotton has access to a corporate espionage firm that can exactly determine if HappyKart will be exercising the option. How much can AllCotton pay this firm for this information?