Problem 1.

DECISION TREES, EVPI and EVMI

Teratex, a textile company that has a productive experience in the foreign market of 25 years, must decide if it
manufactures a new product in its main plant, or if on the contrary the purchase from an external supplier. The
profits depend on the demand of the product. The table shows projected profits, in millions of dollars.

Table 1. Decision process for the commercialization of the product

States of nature
Decision alternative
Demand low- Demand low Demand High -
utility average - utility utility EMV
Manufacture 235 273 307 275,96
Subcontract 213 229 267 239,72
Buy 223 235 276 248,04
Probabilities Ʃ = 1 0,28 0,32 0,4

Questions:

Solution:
a. Use EVPI to determine if the company should try to get a better estimate of the demand.

Decision Trees
Probability Demand
0,28 235 65,8
MANUFACTURE Low
0,32 273 87,36
NODE 2 Low average
0,4 307 122,8
High

0,28 213 59,64

Low
NODE 1 0,32 229 73,28
SUBCONTRACT Low average
NODE 3
0,4 267 106,8
High

0,28 223 62,44

Low
NODE 4 0,32 235 75,2
Low average
0,4 276 110,4
BUY High

Expected value is obtained:

NODE 2 275,96 dollars

NODE 3 239,72 dollars
NODE 4 248,04 dollars

EMV= 275,96 millions

The recommended decision is to manufacture waiting for a payment of

$ 275,96 millions

Knowing the direction the market will go (i.e. having perfect information) is worth $0.

EVwPI= $ 275,96 millions

EVwoPI= $ 275,96 millions
EVPI= $ - millions

b. A test market study of potential product demand is expected to report a favorable (F) or unfavorable (U) condition. The relevant
conditional probabilities are:
P(s1)= 0,4
P(s2)= 0,28
P(F/low) = 0,25 P(s3)= 0,32
P(F/low average) = 0,31
P(F/high) = 0,5

FAVORABLE
Previous Joint Later
Conditional
States of nature probabilities possibilities possibilities
probabilities (F/sj)
P (Sj) P(F n Sj) P(sj/F)
LOW 0,28 0,25 0,07 0,19
LOW AVERAGE 0,32 0,31 0,10 0,27
HIGH 0,4 0,5 0,20 0,54
P(F) 0,37

P(D/low)= 0,75
P(D/ low average)= 0,69
P(D/high)= 0,5

UNFAVORABLE
Previous Later
Conditional Joint possibilities
States of nature probabilities P possibilities
probabilities (D/sj) P(D n Sj)
(Sj) P(sj/D)
LOW 0,28 0,75 0,21 0,33
LOW AVERAGE 0,32 0,69 0,22 0,35
 HIGH 0,4 0,5 0,20 0,32
P(D) 0,63
LOW 0,19 235
MANUFACTURE
LOW AVERAGE 0,27 273 284,213
NODE 4

HIGH 0,54 307

FAVORABLE 0,37 LOW 0,19 213

NODE 2
SUBCONTRACT
LOW AVERAGE 0,27 229 246,551
NODE 5

HIGH 0,54 267

LOW 0,19 223

254,935
BUY LOW AVERAGE 0,27 235
NODE 6
NODE 1
HIGH 0,54 276

LOW 0,33 235

MANUFACTURE
LOW AVERAGE 0,35 273 271,129
NODE 7

HIGH 0,32 307

UNFAVORABLE 0,63 LOW 0,33 213

NODE 3
SUBCONTRACT
LOW AVERAGE 0,35 229 235,722
NODE 8

HIGH 0,32 267

LOW 0,33 223

244,004
BUY LOW AVERAGE 0,35 235
NODE 9

HIGH 0,32 276

c. What is the expected value of market research information?

To find the value of the sample information we have to: VEIM= ǀVEcIM-VEsIMǀ

VEcIM= $ 275,96 millions

VEsIM $ 275,96 millions
VEIM= 0,00

d. What is the efficiency of the information?

VEIM
E= *100
VEIP

$ - 0
E=
$ -

EFFICIENCY OF 0%
284,213

275,960

271,129