Reference no: EM131460712
A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicate a .20 probability that demand will be low and an .80 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] Analyze this problem using a decision tree.
b] What is the maximum alternative?
c] Compute the EVPI and interpret it.
d] Perform sensitivity analysis on p[high].