Reference no: EM132694017

A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.2 probability that demand will be low and a 0.8 probability that demand will be high. If the firm builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium-size facility as a hedge: if demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million.

a) Draw a decision tree for this problem.

b) What is the best alternative for the firm? What is the expected monetary value of the best alternative?

c) Compute the EVPI