Management should do to obtain the highest expected value

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Reference no: EM13968683

Dick Holliday is not sure what he should do. He can build either a large video rental section or a small one in his drug store. He can also gather additional information or simply do nothing. If he gathers additional information, the results could suggest either a favorable or an unfavorable market, but it would cost him $3,000 to gather the information. Holliday believes that there is a fifty percent chance that the information will be favorable. If the rental market is favorable, Holliday will earn $15,000 with a large section or $5,000 with a small. With an unfavorable video-rental market, however, Holliday could lose $20,000 with a large section or $10,000 with a small section. Without gathering additional information, Holliday estimates that the probability of a favorable rental market is .7. A favorable report from the study would increase the probability of a favorable rental market to .9. Furthermore an unfavorable report from the additional information would decrease the probability of a favorable rental market to .4. Of course, Holliday could forget all of these numbers and do nothing. What is your advice to Holliday?

Draw a decision tree and solve to determine what management should do to obtain the highest expected value.

Reference no: EM13968683

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