CHAPTER 24
DISCUSSION QUESTIONS
Q24-1. Before making a decision under conditions of
uncertainty, a manager should try to assess the
probabilities associated with alternative possi-
ble outcomes in order to determine the proba-
ble result of each alternative action. Unless the
probabilities associated with possible outcomes
are determined, the effect of uncertainty cannot
be accounted for adequately, which may result
in inconsistent and unreliable decisions.
Q24-2. Expected value is the weighted average value
of the events for a probability distribution, i.e.,
it is the average value of the events that are
expected to occur.
Q24-3. The standard deviation of the expected value is
a measure of the variability of events within a
probability distribution and, as such, is viewed
as a measure of risk. The larger the standard
deviation, the greater the risk that the actual
result will differ from the expected value.
Q24-4. The coefficient of variation relates the stan-
dard deviation for a probability distribution to
its expected value, thus allowing for differ-
ences in the relative size of different probabil-
ity distributions. The coefficient of variation
provides a comparative measure of risk for
alternatives with different expected values.
Q24-5. A joint probability is the probability of the simul-
taneous occurrence of two or more events
(e.g., the probability of the occurrence of both
event A and event B, denoted as P(AB)),
whereas a conditional probability is the proba-
bility of the occurrence of one event given that
another event has occurred (e.g., the probabili-
ty of the occurrence of event A given that event
B has already occurred, denoted as P(AIB)). A
conditional probability implies that some rela-
tionship exists between the events.
Q24-6. Management should be interested in revising
probabilities as new information becomes
available, because new information may alter
the expected outcomes (i.e., probabilities)
enough to warrant making a different deci-
sion. As a consequence, the revision of prob-
abilities may be necessary in order to provide
a basis for making the best decision.
24-1
Q24-7. Decision trees graphically portray alternatives
and their expected values and include a
sequential decision dimension in the analysis.
They highlight decision points, alternatives,
estimated results, related probabilities, and
expected values. They are especially useful in
evaluating alternatives requiring sequential
decisions that depend upon uncertain out-
comes.
Q24-8. In a discrete probability distribution, the possi-
ble outcomes are limited to certain finite val-
ues (e.g., 10, 11, 12, etc.). The number of
shipments, orders, units of product, etc. are
events that could be described adequately by
a discrete probability distribution. For conven-
ience, the outcomes that occur in a discrete
probability distribution are often limited to a
fairly small number, but this need not neces-
sarily be the case. In contrast, the possible
outcomes that may occur in a continuous
probability distribution are infinite even within
a limited range. Time, weight, volume, length,
temperature, and economic value are exam-
ples of continuous variables because they
can take on an infinite number of values
within a limited range (e.g., between 10 and
11 seconds times of 10.1 seconds, 10.53 sec-
onds, 10.926 seconds, etc. could occur).
Although such items are measured in discrete
units, conceptually they can be subdivided
into infinitely small units of measure (e.g., $2,
$2.34, $2.627, $2.8935, etc.), and practically,
the number of different discrete values an
item may have without subdivision is large
(e.g., the range of sales of $1 items between
10,000 and 20,000 units).
Q24-9. The normal distribution has the following
attractive properties:
(a) The normal distribution is symmetric and
it has only one mode. This means that the
expected value (which is the mean of the
distribution) is equal to the most likely sin-
gle event (the mode). Consequently, the
single best guess is also the expected
value.
24-2
(b) The relationship between the portion of
the area under the curve for any given
interval from the mean, as measured in
standard deviations, is constant for all nor-
mal distributions. This makes it possible to
determine the probability of the occur-
rence of an event within any interval if the
mean and standard deviation are known.
Q24-10. Monte Carlo simulation is used to obtain a
probabilistic approximation of the outcome
of a business system or problem that con-
tains numerous stochastic variables, but can
be modeled mathematically. Its procedure
utilizes statistical sampling techniques and
is computer oriented.
Q24-11. A normal distribution is a symmetrical distri-
bution. The expected value (the mean) and
the most likely event (the mode) are equal.
Since the most likely event would be used
even when the distribution of probable out-
comes is not considered specifically, and
since the most likely event and the expected
value are the same for a normal distribution,
the expected net present value would be the
same whether probability analysis is incorpo-
rated or not. Nevertheless, probability analy-
sis should be incorporated into the capital
expenditure evaluation because it provides a
way for management to evaluate risk.
Q24-12. A mutiperiod problem expands the analysis
from a single variable to multiple variables
(i.e., the cash flows from each period are
treated as different random variables). As a
consequence, the expected net present value
of a capital expenditure proposal is treated as
a random variable drawn from a multivariate
probability distribution. The variance for a
multivariate distribution is computed by sum-
ming the variances for each variable if the
variables are independent, or by summing
the standard deviations and squaring the total
if the variables are perfectly correlated
(squaring the total incorporates the interac-
tion between the dependent variables). To
consider the time value of money in a
mutiperiod capital expenditure proposal, the
periodic variances and the periodic standard
deviations should be discounted at the com-
pany’s weighted average cost of capital.
Q24-13. Cash flows are independent if the magni-
tude of cash flows in one period is not in any
way affected by the magnitude of cash flows
24-2
Chapter 24
in another period. Independent cash flows
might be expected to occur when a capital
expenditure relates to the production of an
established product or service; the demand
for which is expected to vary in response to
temporary changes in consumer tastes and
preferences or the capacity to purchase,
which are uncorrelated between periods.
Q24-14. Cash flows are perfectly correlated if the mag-
nitude of cash flows in a subsequent period is
dependent upon the magnitude of cash flows
in a preceding period. Perfectly correlated
cash flows might be expected to occur if a
capital expenditure relates to the production of
a new product or the entrance of a product
into a new market. In such a case, consumer
acceptance of the product in one period might
be expected to have a direct bearing an the
level of sales in the following period.
Q24-15. If the periodic cash flows are neither
independent nor perfectly correlated, the
variance of the net present value of a capital
expenditure can be computed by (a) dividing
the period cash flows into independent and
dependent components; (b) computing the
periodic variances for the independent cash
flows and then discounting and summing to
get the variance for the net present value of
the independent cash flows; (c) computing
the periodic variances for the dependent
cash flows, taking the square root of each
variance to get the periodic standard devia-
tions, discounting and summing the periodic
standard deviations, and squaring the total
to get the variance for the net present value
of the dependent cash flows; and (d) adding
the variance for the net present value of the
independent cash flows to the variance of
the net present value of the dependent cash
flows.
Q24-16. MADM stands for multi-attribute decision
model, and it is an expenditure evaluation
tool that explicitly incorporates both quanti-
tative and nonquantitative factors into the
decision analysis. Traditional economic eval-
uation tools do not incorporate qualitative
factors into the decision model, yet most of
the benefits to be derived from investments
in new technologies are strategic and diffi-
cult to quantify. MADM attempts to remedy
this problem by giving weight to noneco-
nomic variables.
Chapter 24 24-3

EXERCISES
E24-1
(1)
xi P(xi) E(x)
Income or Income or
Monthly (Loss) (Loss)
Sales Conditional Expected
Volume Value Probability Value
3,000 $(35,000) .05 $(1,750)
6,000 5,000 .15 750
9,000 30,000 .40 12,000
12,000 50,000 .30 15,000
15,000 70,000 .10 7,000
1.00 $33,000

(2) (1) (2) (3) (4) (5)

xi (xi – E(x)) (xi – E(x)) 2 P(xi) P(xi)(xi – E(x))2
Difference
Income from
or (Loss) Expected
Conditional Value
Value ($33,000) (2) Squared Probability (3) × (4)
$(35,000) $(68,000) $4,624,000,000 .05 $231,200,000
5,000 (28,000) 784,000,000 .15 117,600,00
30,000 (3,000) 9,000,000 .40 3,600,000
50,000 17,000 289,000,000 .30 86,700,000
70,000 37,000 1,369,000,000 .10 136,900,000
Variance ........................................................................... $576,000,000

Standard deviation ( σ) = $576,000,000 = $24, 000

Coefficient = Standard deviation( σ ) = $24, 00

00
of variation Expected value (E( x )) $33, 000 = .727
24-4 Chapter 24

E24-2
(1) (1) (2) (3) (4) (5)
xi P(xi) E(x)
Monthly Unit Conditional Frequency Expected
Sales Contribution Value Based Value
Volume Margin (1) × (2) Probability (3) × (4)
10,000 $10 $100,000 9/60 = .15 $ 15,000
11,000 10 110,000 15/60 = .25 27,500
12,000 10 120,000 18/60 = .30 36,000
13,000 10 130,000 9/60 = .15 19,500
14,000 10 140,000 6/60 = .10 14,000
15,000 10 150,000 3/60 = .05 7,500
60/60 = 1.00 $119,500

(2) (1) (2) (3) (4) (5)

xi (xi – E(x)) (xi – E(x))2 P(xi) P(xi)(xi – E(x))2
Deviation from
Conditional $119,500
Value Expected Value (2) Squared Probability (3) × (4)
$100,000 $(19,500) $380,250,000 .15 $ 57,037,500
110,000 (9,500) 90,250,000 .25 22,562,500
120,000 500 250,000 .30 75,000
130,000 10,500 110,250,000 .15 16,537,500
140,000 20,500 420,250,000 .10 42,025,000
150,000 30,500 930,250,000 .05 46,512,500
σ )..............................................................................
Variance (σ2 $184,750,000

Standard deviation ( σ ) = Variance ( σ 2 ) = $184,750,000 = $13, 592

Coefficient Standard deviation ( σ ) 92

$13, 59
= = = .114
of variation Expected value (E( x )) $119, 500
Chapter 24 24-5

E24-3
Cost to purchase thermocouplers:
Units needed annually (18,000 ÷ (1 – .10)) ........................................ 20,000
Unit cost................................................................................................ × $15
Total estimated cost if thermocouplers purchased.......................... $300,000

Weighted average unit cost (expected value) to manufacture thermocouplers:

Estimated Weighted Average

per Unit Variable Unit Cost
Cost Probability (Expected Value)
$10 .1 $ 1.00
12 .3 3.60
14 .4 5.60
16 .2 3.20
$13.40

Estimated variable manufacturing cost (18,000 units × $13.40) .... $241,200

Additional fixed manufacturing cost ................................................ 32,500
Total estimated cost if thermocouplers manufactured ................... $273,700

Manufacturing yields an estimated savings of $26,300 ($300,000 – $273,700), subject to

the accuracy of estimated data. If data are accurate, manufacturing appears desirable;
assuming that the savings represents an acceptable rate of return on additional
invested capital, there is no better alternative use of limited available facilities and
equipment, and quality and production schedule demands can be met.
24-6 Chapter 24

E24-4
Table of expected values of possible strategies (000s omitted):
Expected
Purchases/Sales 100 120 140 180 Value
100 $25 $25 $25 $25 $25.0
120 15 40 40 40 37.5
140 5 301 55 55 42.52
180 (15) 10 35 85 32.5
Probability .1 .3 .4 .2

1Contribution margin for ordering 140,000 units and selling 120,000 units:
Sales (120,000 × $1.25) ........................................................................ $150,000
Cost of units ($50,000 + (140,000 × $.50)) ......................................... 120,000
$ 30,000
2Expected value for purchasing 140,000 units:
$ 5 × .1.................................................................................................. $ .5
30 × .3.................................................................................................. 9.0
55 × .4 ................................................................................................. 22.0
55 × .2.................................................................................................. 11.0
$42.5

Jessica Company should purchase 140,000 units for December, according to the expected
value decision model, because this number of units produces the largest expected
value, $42,500.

E24-5
(1) Payoff table of expected values of possible strategies
Sales Expected
Contribution
Order 10,000 20,000 30,000 40,000 Margin
10,000 $2,000 $2,000 $2,000 $2,000 $2,000
20,000 (1,000) 4,000 4,000 4,000 3,500
30,000 (4,000) 1,0001 6,000 6,000 4,0002
40,000 (7,000) (2,000) 3,000 8,000 2,500

Probability 5 ÷ 50 = .1 10 ÷ 50 = .2 20 ÷ 50 = .4 15 ÷ 50 = .3

1Contribution margin for ordering 30,000 hot dogs and selling 20,000 hot dogs:
Sales (20,000 × $.50) ............................................................................ $10,000
Cost of hot dogs (30,000 × $.30) ........................................................ 9,000
Contribution margin............................................................................. $ 1,000
Chapter 24 24-7

E24-5 (Concluded)

2Expected contribution margin for ordering 30,000 hot dogs:

$(4,000) × .1..................................................................................... $ (400)
$ 1,000 × .2 .................................................................................... 200
$ 6,000 × .4 .................................................................................... 2,400
$ 6,000 × .3 .................................................................................... 1,800
Expected value..................................................................................... $4,000

(2) The expected value of perfect information is the difference between the average
contribution margin using the best strategy (ordering 30,000 hot dogs) and the
probabilities and average contribution margin if Wurst knew in advance what the
sales level would be each Saturday.

Average contribution margin if Wurst knew sales level:

$2,000 × .1........................................................ $ 200
$4,000 × .2........................................................ 800
$6,000 × .4........................................................ 2,400
$8,000 × .3........................................................ 2,400 $5,800
Average contribution margin using expected value
decision rule to determine best strategy (from 1) 4,000
Contribution margin improved by............................... $1,800

Since the contribution margin would be improved by $1,800, Wurst could afford
to pay up to $1,800 for “perfect” information.

E24-6
(1) (2) (3) (4) (5)
Prior
Probability ×
Conditional Posterior
Prior Conditional Probability Probability
Demand Probability Probability (2) × (3) (4) ÷ (4) Total
30,000 .10 .20 .02 .10
40,000 .10 .50 .05 .25
50,000 .50 .20 .10 .50
60,000 .30 .10 .03 .15
1.00 1.00 .20 1.00
24-8 Chapter 15

E24-7

Expected
Payoffs Value

Market demand increases (.3) $100,000 $ 30,000

$40,000
Market demand remains same (.5) 50,000 25,000

Market demand declines (.2) –25,000 –5,000

$ 50,000
Moving cost –10,000
Move to $ 40,000
Mall

Do not
move

Market demand increases (.3) 80,000 $ 24,000

Market demand remains same (.5) 40,000 20,000

$42,000
Market demand declines (.2) –10,000 –2,000
$ 42,000

Since the expected value of not moving exceeds that of moving, the manager
should not move the stereo store to the shopping mall ($42,000 > 40,000).
CGA-Canada (adapted). Reprint with permission.
Chapter 24 24-9

E24-8

Expected
Payoffs Value

High demand (.4) $ 50,000 $ 20,000

$26,000
Medium demand (.3) 30,000 9,000

Low demand (.3) –10,000 –3,000

$ 26,000
Make

Buy

High demand (.4) 35,000 $ 14,000

Medium demand (.3) 30,000 9,000

$24,500
Low demand (.3) 5,000 1,500
$ 24,500

The firm should make the sub-assembly rather than buy it because the expected
value of making the sub-assembly is $26,000, which is greater than the expected
value of buying ($24,500).
CGA-Canada (adapted). Reprint with permission.
 24-10 Chapter 24

E24-9

Expected Expected
Payoff Value
Successful (.6)
$ 200,000 $ 120,000

$120,000

Unsuccessful (.4) –0– –0–

A
el

$ 120,000
rc
Pa
on
d
Bi

Successful (.5)
$ 290,0001 $ 145,000

$190,000
g
in
n
Bid

zo
Re

Unsuccessful (.5)
on P

90,000 2 45,000
r
fo
y
pl

$ 190,000
arce

Ap

$190,000
Successful (.8)
lB

Do
No

$152,000
tA
pp
ly f
or
Re
zon
ing

$ 100,000 $ 100,000

Unsuccessful (.2)
$ –0– $ –0–

1$300,000 expected profit – $10,000 cost of applying for rezoning.

2$100,000 expected profit – $10,000 cost of applying for rezoning.

The land developer should bid on parcel B, and, if successful, apply for rezoning
because the expected value of this alternative is greater than any other.
CGA-Canada (adapted). Reprint with permission.
Chapter 24 24-11

E24-10

(1) 55,000 units ± 45,000 units 10, 000 units

σ= = = 7, 496 units
(.667 σ × 2) 1.334 σ

(2) $193, 750 fixed cos t

= 38, 750 units to breakeven
$5 CM per unit

50, 000 units at mean ± 38, 750 units to breakeven

= 1 .5 σ
7, 496 units in s tan dard deviation
The probability of making a profit is equal to the area under the normal curve
above the breakeven point, which is approximately 93% (.43 for the area between
the breakeven point and the mean, which is the area for an interval of 1.5 stan-
dard deviations from the mean found in Exhibit 24-8 of the textbook, plus .50 for
the area above the mean).

E24-11
(1) (2) (3) (4)
Expected Value Present Value
of After-Tax Present of Expected
Net Cash Value After-Tax
(Outflow) of $1 Net Cash Flow
Year Inflow @10% (2) × (3)
0 $(20,000) 1.000 $(20,000)
1 5,000 .909 4,545
2 5,000 .826 4,130
3 5,000 .751 3,755
4 5,000 .683 3,415
5 5,000 .621 3,105
6 5,000 .564 2,820
Expected net present value............................. $ 1,770

OR

(1) (2) (3) (4)

Expected Value Present Present Value
of After-Tax Value of of Expected
Net Cash Annuity After-Tax
(Outflow) of $1 Net Cash Flow
Year Inflow @10% (2) × (3)
0 $(20,000) 1.000 $(20,000)
1– 6 5,000 4.355 21,775
Expected net present value............................. $ 1,775*

*The difference in the results is due to rounding in the present value tables.
24-12 Chapter 24

E24-12
(1) (2) (3) (4) (5) (6)
Present
Value of Present
Periodic Present Periodic $1 at 12% Value of
Standard Value of Variance Squared Variance
Year Deviation $1@12% (2) × (2) (3) × (3) (4) × (5)
0 0 1.000 0 1.000000 0.00
1 $500 .893 $250,000 .797449 $199,362.25
2 500 .797 250,000 .635209 158,802.25
3 500 .712 250,000 .506944 126,736.00
4 500 .636 250,000 .404496 101,124.00
5 500 .567 250,000 .321489 80,372.25
6 500 .507 250,000 .257049 64,262.25
7 500 .452 250,000 .204304 51,076.00
8 500 .404 250,000 .163216 40,804.00
Variance of net present value ..................................................... $822,539.00

Standard deviation of net present value = $822, 539 = $906.94

E24-13
(1) (2) (3) (4)
Present Value
Periodic Present of Standard
Standard Value of Deviation
Year Deviation $1 @ 10% (2) × (3)
0 0 1.000 0
1 $1,000 .909 $909
2 1,000 .826 826
3 1,000 .751 751
4 1,000 .683 683
5 1,000 .621 621
Standard deviation of NPV .................... $3,790

OR

(1) (2) (3) (4)

Present Present Value
Periodic Value of of Standard
Standard Annuity of Deviation
Year Deviation $1@ 10% (2) × (3)
0 0 1.000 0
1-5 $1,000 3.791 $3,791
Standard deviation of NPV .................... $3,791*

*The difference in the results is due to rounding in the present value tables.
Chapter 24 24-13

E24-14
(1) (2) (3) (4) (5) (6)
Periodic Present
Standard Value of Present
Deviation of Present Periodic $1 at 12% Value of
Independent Value of Variance Squared Variance
Year Cash Flow $1@12% (2) × (2) (3) × (3) (4) × (5)
0 0 1.000 0 1.000000 0.00
1 $1,000 .893 $1,000,000 .797449 $797,449
2 1,000 .797 1,000,000 .635209 635,209
3 1,000 .712 1,000,000 .506944 506,944
4 1,000 .636 1,000,000 .404496 404,496
5 1,000 .567 1,000,000 .321489 321,489
6 1,000 .507 1,000,000 .257049 257,049
7 1,000 .452 1,000,000 .204304 204,304
Variance of NPV for independent cash flows.......................... $3,126,940

(1) (2) (3) (4)

Present Value
Periodic Present of Standard
Standard Value of Deviation
Year Deviation $1 @ 10% (2) × (3)
0 0 1.000 0.00
1 $1,500 .893 $1,339.50
2 1,500 .797 1,195.50
3 1,500 .712 1,068.00
4 1,500 .636 954.00
5 1,500 .567 850.50
6 1,500 .507 760.50
7 1,500 .452 678.00
Standard Deviation of NPV for
dependent cash flows ...................... $6,846.00

Variance of NPV for dependent cash flows = ($6,846)2 = $46,867,716

Variance of NPV for independent cash flows ............ $ 3,126,940

Variance of NPV for dependent cash flows................ 46,867,716
Variance of total NPV of investment ........................... $49,994,656

Standard deviation of total NPV of investment = $49, 994, 656 = $7, 070..69
24-14 Chapter 24

E24-15

(1) The 95% confidence interval for the net present value is a range between a low
of –$20,000 ($30,000 expected NPV – (2 × $25,000 standard deviation)) and a high
of $80,000 ($30,000 expected NPV + (2 × $25,000 standard deviation)).

(2) There is a .88493 probability that the NPV of the investment will be positive, i.e.,
the .5 area above the mean plus the .38493 area below the mean (determined
µ – x) ÷ σ = ($30,000
from the table of Z values in Exhibit 24-8 of the text for (µ
expected NPV – 0) ÷ $25,000 = 1.20σ σ).
Chapter 24 24-15

PROBLEMS
P24-1
(1) Deterministic approach:
Sales (60,000 units most likely sales volume
× $100) ................................................................. $6,000,000
Variable costs:
Direct materials (60,000 units × $25) ................. $1,500,000
Direct labor (60,000 units × $8.80 per
hour most likely rate × 2 hours)................ 1,056,000
Variable overhead (60,000 units ×
($.40 supplies + $.35 materials
handling + $1.25 heat, light, and power)
× 2 hours) .................................................... 240,000
Promotion fee (60,000 units × $6) ...................... 360,000 3,156,000
Contribution margin ..................................................... $2,844,000
Additional fixed costs:
Supervisor salary ................................................ $ 28,000
Equipment lease rentals ..................................... 150,000 178,000
Annual pretax advantage of introducing new
product ................................................................. $2,666,000

(2) Expected value approach:

Sales in Units Probability Expected Value
50,000 .25 12,500
60,000 .45 27,000
70,000 .20 14,000
80,000 .10 8,000
61,500

Labor Hour Rate Probability Expected Value

$8.50 .30 $2.55
8.80 .50 4.40
9.00 .20 1.80
$8.75
24-16 Chapter 24

P24-1 (Concluded)

Sales (61,500 expected value × $100)......................... $6,150,000

Variable costs:
Direct materials (61,500 units × $25) ................. $1,537,500
Direct labor (61,500 units × $8.75
expected value × 2 hours) ........................ 1,076,250
Variable overhead (61,500 × $2 per labor
hour × 2 hours) ........................................... 246,000
Promotion fee (61,500 units × $6) ...................... 369,000 3,228,750
Contribution margin ..................................................... $2,921,250
Additional fixed costs:
Supervisor salary ................................................ $ 28,000
Equipment lease rentals ..................................... 150,000 178,000
Expected annual pretax advantage ............................ $2,743,250

(3) In this situation, Monte Carlo simulation could be used. A linear equation for the
net advantage would have to be developed that included the two variable items
(sales volume and hourly direct labor costs) treated as independent stochastic
variables. The probability distributions for sales volume and hourly direct labor
cost would be simulated and pairs of values would be selected for entry into the
equation, using a random number generator. The net pretax advantage would be
calculated and recorded, and then a new set of values for the stochastic vari-
ables would be determined and reentered into the equation. A large number of
iterations would be calculated and recorded to determine the approximate
distribution of the net pretax advantage. The distribution would have a calculat-
ed mean (which would be interpreted as the expected annual net pretax advan-
tage) and a standard deviation (which could be interpreted as a measure of the
product’s risk).
Chapter 24 24-17

P24-2
Video Recreation Inc. should adopt Plan 3 because it results in the least cost of the
three alternatives as demonstrated below:

Expected
Number of Number
Service Calls × Probability = of Calls
400 .1 40
700 .3 210
900 .4 360
1,200 .2 240
1.0 850

Expected
Parts Cost Value of
Per Repair × Frequency = Parts Cost
$30 .15 $ 4.50
40 .15 6.00
60 .45 27.00
90 .25 22.50
1.00 $60.00

Plan 1
Vendor fees (6 vendors × $15,000 fee per vendor)........................... $ 90,000
Service calls (850 calls × $250 per call) ............................................ 212,500
Parts ($60 expected value per call × 850 calls × (1 + 10% markup)) 56,100
Estimated total cost of Plan 1 ............................................................ $358,600

Plan 2
Urban service calls (850 calls × 60% urban × $450 per call) .......... $229,500
Rural service calls (850 calls × 40% rural × $350 per call) ............. 119,000
Parts ($60 expected value per call × 850 calls)................................. 51,000
Estimated total cost of Plan 2 ............................................................ $399,500

Plan 3
Employee salaries (9 employees × $24,000 average salary) ........... $216,000
Employee fringe benefits ($216,000 employee wages × 35%) ........ 75,600
Preventive maintenance parts (200 calls per employee ×
9 employees × $15 in parts per call) ........................................ 27,000
Repair parts ((850 calls × (1 – 30%)) ×
($60 expected value per call × (1 – 20%)))................................ 28,560
Estimated total cost of Plan 3 ............................................................ $347,160
24-18 Chapter 24

P24-3
Expected Value of Bearings Expected Value of Bearings
Rejected During Assembly Rejected During Performance Testing
Expected Expected
Quantity Probability Value Quantity Probability Value
100 .50 50.0 20 .40 8.0
60 .25 15.0 15 .30 4.5
30 .15 4.5 10 .20 2.0
5 .10 0.5 5 .10 0.5
70.0 15.0

(
(Variable
(
Hourly cost to
replace bearing
=
( cost
Direct labor
per hour
+ overhead
cost per hour
= ($8) + (1.5)($8)
= $20

( ( (
Cost of rejections
during assembly
per lot
=
( Expected value of
bearings rejected
during assembly
×
( Replacement
time per
unit
×
( Cost to
replace each
bearing
= 70 × 6 / 60 hour × $20 per hour
= $140

(
(
Cost of rejections Expected value of ( (
during performance
testing per lot
=
bearings rejected
during performance
testing
× ( Replacement
time per
unit
× ( Cost to
replace each
bearing

= 15 × 1 hour × $20 per hour

= $300

(
((
((
Maximum amount
for quality
control program
=
Cost of rejections
during assembly
per lot
(
Cost of rejections
+ during performance ×
testing per lot
(Number
of lots
(
= ($140 + $300) × (1,000,000 units ÷ 1,000 units per lot)
= $440,000
Chapter 24 24-19

P24-4
(1) The payoff table of expected contribution margins for Kenton Clothiers’ shirt
order sizes follows:

Possible Actions Contribution Margin (Conditional Value) Contribution Margin

(Quantities to for Possible Sales Quantities (Expected Value of
be Ordered) 100 200 300 400 Each Strategy)
100 $ 700* $ 700 $ 700 $ 700 $ 700
200 100** 1,600 1,600 1,600 1,420
300 (300) 1,200 2,700 2,700 1,620
400 (500) 1,000 2,500 4,000 1,480***
Probability 3/25 = .12 12/25 = .48 9/25 = .36 1/25 = .04

* 100 shirts at the regular $30 sales price × $7 CM per shirt = $700 CM
** (100 shirts at the regular $30 sales price × $8 CM per shirt) – (100 shirts at the
$15 reduced price × $7 loss per shirt) = $100 CM
*** (.12 probability × $(500)) + (.48 probability × $1,000) + (.36 probability × $2,500) +
(.04 probability × $4,000) = $1,480 CM

(2) The best strategy for Kenton Clothiers would be to order 300 shirts each year
because it would result in the largest contribution margin over time. The coeffi-
cient of variation for the best strategy (i.e., purchasing 300 shirts each year) is
.615 determined as follows:

(1) (2) (3) (4) (5)

xi (xi – E(x)) (xi – E(x))2 P(xi) P(xi)(xi – E(x))2
Deviation from
Conditional $1,620 Columns
Value Expected Value Col. (2) 2 Probability (3) × (4)
$ (300) $1,920 $3,686,400 .12 $442,368
1,200 (420) 176,400 .48 84,672
2,700 1,080 1,166,400 .36 419,904
2,700 1,080 1,166,400 .04 46,656
σ ) .................................................................................
Variance (σ2 $993,600

Standard deviation ( σ ) = Variance ( σ )2 = $993, 600 = $996.795

Coefficient Standard Deviation ( σ ) $996.795

= = = .615
of variation Expected Value (E( σ )) $1, 620
24-20 Chapter 24

P24-4 (Concluded)

(3) The expected value of perfect information is $364 determined as follows:

Average contribution if Kenton Clothiers knew sales in advance and ordered just
enough to meet sales demand:

CM Per Expected
Quantity Unit Sold Total CM Probability Value
100 $ 7 $ 700 .12 $ 84
200 8 1,600 .48 768
300 9 2,700 .36 972
400 10 4,000 .04 160
Expected value with perfect information .............................. $ 1,984
Less expected value of best strategy under uncertainty
(ordering 300 shirts from requirement (1) above).......... 1,620
Expected value of perfect information................................... $ 364

P24-5

(1) (1) (2) (3) (4)

Prior Conditional Posterior
Events Probability Probability (1) × (2) Probability
1,600 .20 .25 .050 .1250
2,000 .50 .25 .125 .3125
2,400 .20 .75 .150 .3750
2,800 .10 .75 .075 .1875
1.00 .400 1.0000
(2)
Actions Events (House Size Most in Demand)
Size To Expected
Build 1,600 2,000 2,400 2,800 Value
1,600 $200,000 $180,000 $160,000 $140,000 $167,500
2,000 160,000 400,000 360,000 320,000 340,000
2,400 120,000 320,000 600,000 540,000 441,250
2,800 80,000 240,000 480,000 800,000 415,000
Posterior
probability .1250 .3125 .3750 .1875

Gant should be advised to build the 2,400 square-foot houses on the tract of
land because that course of action has the highest expected value.
Chapter 24 24-21

P24-6

(1) Expected value of outside printer’s offer:

Expected
Enrollments Probability Value
25,000 .05 1,250
26,000 .15 3,900
27,000 .40 10,800
28,000 .25 7,000
29,000 .15 4,350
1.00 27,300

Fees to be paid to the outside printer:

Fixed fee.......................................................... $325,000
Variable fee ((27,300 – 25,000) × $15) ........... 34,500 $359,500

Savings available from closing Printing Department:

Lease income from renting equipment............ $ 33,000
Avoidable fixed costs:
Salaries and benefits ($160,000
× 110%)................................ $176,000
Less cost of part-time
clerk ($16,000 × 110% ×
3/5 week) ............................. (10,560)
Less employee severance pay
(($160,000 – $16,000) ÷
12 months) .......................... (12,000) 153,440
Telephone
($4,000 – ($80 × 12 months)).................. 3,040
Occupancy and administration
($10,800 + $7,300) ................................... 18,100
Avoidable variable costs:
Materials, supplies, and postage
((($165,100 ÷ 26,000) – $1) × 27,300) 146,055 353,635
Increase in total costs from acceptance of
printer’s offer...................................................... $ 5,865

In this case, the outside printer’s offer should not be accepted because the total
costs would increase by $5,865.
24-22 Chapter 24

P24-6 (Concluded)

(2) Revised expected value of outside printer’s offer:

(1) (2) (3) (4) (5)
Revised
Prior Conditional Posterior Expected
Enrollments Probability Probability (1) × (2) Probability Value
25,000 .05 .90 .045 .045 ÷ .260 = .173 4,325
26,000 .15 .90 .135 .135 ÷ .260 = .519 13,494
27,000 .40 .10 .040 .040 ÷ .260 = .154 4,158
28,000 .25 .10 .025 .025 ÷ .260 = .096 2,688
29,000 .15 .10 .015 .015 ÷ .260 = .058 1,682
1.00 .260 1.000 26,347

Fees to be paid to the outside printer:

Fixed fee .............................................................................. $325,000
Variable fee ((26,347 – 25,000) × $15)................................ 20,205 $345,205
Savings available from closing Printing Department:
Lease income from renting equipment ............................ $ 33,000
Avoidable fixed costs:
Salaries and benefits ($160,000
× 110%) ............................................... $176,000
Less cost of part-time clerk
($16,000 × 110% ×
3/5 week) ..................................... (10,560)
Less employee severance pay
(($160,000 – $16,000)
÷ 12 months) ............................... (12,000) 153,440
Telephone and telegraph
($4,000 – ($80 × 12 months)).................................. 3,040
Occupancy and administration
($10,800 + $7,300) .................................................. 18,100

Avoidable variable costs:

Materials, supplies, and postage
((($165,100 ÷ 26,000) – $1) × 26,347) ..................... 140,956 348,536
Decrease in total costs from acceptance of
printer’s offer....................................................................... $ (3,331)

Considering the new information, the outside printer’s offer should be accepted
because the total costs would decrease by $3,331.
Chapter 24 24-23

P24-7
The tests should be administered because the expected value is $115 per appli-
cant greater than the case where no test is administered ($1,015 – $900).

Expected
Payoffs Value
1
Satisfactory (.7) $ 2,500 $ 1,750
$1,600
Abbreviated Training (.9)
$1,420 4
Unsatisfactory (.3) –500 –150

Not hired (.1) –200 $ 1,600

Acceptable
Score (.75)

$1,015 5

Unacceptable Satisfactory (.2) $ 2,200

2
$ 440
Score $ –200
Test (.75)
Full training (.1)

Unsatisfactory (.8) –800 –640

$ –200 Not hired (.9) –200 $ –200

3
No Satisfactory (.5) $ 2,400 $ 1,200
Test $ 900
Full training
$ 900
Unsatisfactory (.5) –600 –300

Not hired 0 $ 900

24-24 Chapter 24

P24-7 (Concluded)
1Successful hire salary savings ................ $3,000
Less costs:
Testing.................................................... $200
Abbreviated training ............................ 300 500
Payoff ......................................................... $2,500

2Successful hire salary savings ................. $3,000

Less costs:
Testing ................................................... $200
Full training............................................ 600 800
Payoff ......................................................... $2,200

3Successful hire salary savings ................. $3,000

Less full training cost................................. 600
Payoff ......................................................... $2,400

4Expectedvalue of abbreviated training ................................ $1,600 × .9 = $1,440

Expected value of not hiring ................................................... –200 × .1 = –20
Expected value when test score acceptable ................................................... $1,420
5Expectedvalue of acceptable test score ............................... $1,420 × .75 = $1,065
Expected value of unacceptable test score........................... –200 × .25= –50
Expected value of administering test .............................................................. $1,015
Chapter 24 24-25

P24-8
Sales Material State of Sales
Price Lot Size Economy Demand Expected Payoff
$5.25 200,000 Weak 180,000 ($5.25 × 180,000) – ($3 × 200,000) = $345,000
5.25 200,000 Strong 200,000 ($5.25 × 200,000) – ($3 × 200,000) = $450,000
5.25 240,000 Weak 180,000 ($5.25 × 180,000) – ($2.90 × 240,000) = $249,000
5.25 240,000 Strong 200,000 ($5.25 × 200,000) – ($2.90 × 240,000) = $354,000
5.00 200,000 Weak 200,000 ($5 × 200,000) – ($3 × 200,000) = $400,000
5.00 200,000 Strong 240,000 ($5 × 200,000) – ($3 × 200,000) = $400,000
5.00 240,000 Weak 200,000 ($5 × 200,000) – ($2.90 × 240,000) = $304,000
5.00 240,000 Strong 240,000 ($5 × 240,000) – ($2.90 × 240,000) = $504,000
Expected
Payoffs Value
Weak economy (.6) $345,000 $ 207,000

$387,000
Order 200,000

Strong economy (.4) 450,000 180,000

$ 387,000
$387,000

Weak economy (.6) 249,000 $ 149,400

Select $291,000
$5.25 Order 240,000
Sales
Price
Strong economy (.4) 354,000 141,600
$ 291,000

Weak economy (.6) 400,000 $ 240,000

Select $400,000
$5.00 Order 200,000
Sales
Price
Strong economy (.4) 400,000 160,000
$ 400,000

$400,000
Weak economy (.6) 304,000 $ 182,400

$384,000
Order 240,000

Strong economy (.4) 504,000 201,600

$ 384,000

Slick Inc. should set the sales price at $5.00 per unit and order 200,000 units of mate-
rial, because this course of action will result in the greatest expected value ($400,000
contribution margin).
24-26 Chapter 24

P24-9
(1)
Expected Expected
Payoff Value
Do Not Introduce
$ –500,000 $ –500,000

$2,300,000

Int
rod
)
(.5

uc
ful

eN
s
es

ew
cc

Pr
Su

Successful (.8) 2
od
$ 3,500,000 $ 2,800,000
st

uc
Te

$900,000 1 $2,300,000
Te
y1

Unsuccessful (.2)
st

3
teg

$ 2,500,000 –500,000
No
ra

tS

$ 2,300,000
St

uc
—

ce
ign

Do Not Introduce
ss

$ –500,000
pa

ful
am

(.5
tC

)
s
Te

$1,000,000 $ –500,000
Int
rod
uc
eN
ew
Na

Successful (.2)
Pr
tio

3,500,000 $ 700,000
od
nw

uc
id
e

t
Pr

$ –1,300,000
om
ot

Unsuccessful (.8)
io

–2,500,000 –2,000,000
n
No

$ –1,300,000
Te
s tC
am
pa
ig
n
—
St
ra
te
gy

$ 1,000,000 Successful (.5) 4

2

$ 4,000,000 $ 2,000,000

Unsuccessful (.5) 5
–2,000,000 –1,000,000
$ 1,000,000

1 $2,300,000 × .5 = $1,150,000
– 500,000 × .5 = –250,000
$ 900,000
2Successful with test = ($40 – $30 – $6 – $.5) million = $3.5 million
3Unsuccessful with test = ($16 – $12 – $6 – $.5) million = $ –2.5 million
4Successful without test = ($40 – $30 – $6) million = $4 million
5Unsuccessful without test = ($16 – $12 – $6) million = $ –2 million
Chapter 24 24-27

P24-9 (Concluded)

(2) If the probability estimates can be relied upon, management should conduct the
nationwide promotion and distribution without first performing a test campaign
because the expected value of Strategy 2 is $100,000 greater than the expected
value of Strategy 1.

(3) Criticism of the expected value decision criterion would include:

(a) Selection of the probabilities associated with the possible outcomes for the
alternative strategies is a subjective process. If the probability estimates are
biased, the expected values will be biased.
(b) The values for the alternative courses of action are estimates that could be
inaccurate.
(c) The decision model does not incorporate psychological factors. For
instance, people are often risk averse, and personal evaluations will not nec-
essarily coincide with monetary evaluations.
(d) A model is often overly simplified to make it manageable and may conse-
quently leave out important considerations or assumptions.
24-28 Chapter 24

P24-10
(1) Expected value of periodic cash flows:
(1) (2) (3) (4) (5)
Expected Expected
Expected Value of Value of
Value of Annual cash Annual Annual
Annual Contribution Inflow Fixed Pretax Net
Sales Margin From Sales Cash Cash Inflow
in Units Per Unit (1) × (2) Outflow (3) – (4)
4,000 $14 $56,000 $8,100 $47,900

(1) (2) (3) (4)

Tax Annual
Tax Basis Depreciation Tax
Year (Cost) Rate Depreciation
1 $200,000 .143 $ 28,600
2 200,000 .245 49,000
3 200,000 .175 35,000
4 200,000 .125 25,000
5 200,000 .089 17,800
6 200,000 .089 17,800
7 200,000 .089 17,800
8 200,000 .045 9,000
9 200,000 .000 0
10 200,000 .000 0
$200,000

(1) (2) (3) (4) (5) (6)

Expected Expected Expected
Expected Value of Value Value of
Value of Taxable of Tax After-Tax Net
Pretax Net Tax Income Liability Cash Flow
Year Cash Flow Depreciation (2) – (3) (4) × 40% (2) – (5)
0 $(200,000) 0 0 0 $(200,000)
1 47,900 $28,600 $19,300 $ 7,720 40,180
2 47,900 49,000 (1,100) (440) 48,340
3 47,900 35,000 12,900 5,160 42,740
4 47,900 25,000 22,900 9,160 38,740
5 47,900 17,800 30,100 12,040 35,860
6 47,900 17,800 30,100 12,040 35,860
7 47,900 17,800 30,100 12,040 35,860
8 47,900 9,000 38,900 15,560 32,340
9 47,900 0 47,900 19,160 28,740
10 47,900 0 47,900 19,160 28,740
$ 167,400
Chapter 24 24-29

P24-10 (Continued)

Expected value of the periodic standard deviation:

(1) (2) (3) (4) (5)

Pretax After-Tax
Cash Flow Cash Flow
Standard Value of Value of
Deviation Pretax Standard After-Tax Standard
in Units Cash Flow Deviation Portion Deviation
of Sales per Unit (1) × (2) (1 – 40%) (3) × (4)
1,750 $14 $24,500 60% $14,700

(2) Expected net present value of investment:

(1) (2) (3) (4)

Expected Present
Value of Present Value of
After-Tax Net Value of After-Tax Net
Year Cash Flow $1 at 12% Cash Flow
0 $(200,000) 1.000 $ (200,000)
1 40,180 .893 35,881
2 48,340 .797 38,527
3 42,740 .712 30,431
4 38,740 .636 24,639
5 35,860 .567 20,333
6 35,860 .507 18,181
7 35,860 .452 16,209
8 32,340 .404 13,065
9 28,740 .361 10,375
10 28,740 .322 9,254
Expected net present value ................................... $ 16,895
24-30 Chapter 24

P24-10 (Concluded)

(3) Variance and standard deviation of expected net present value:

(1) (2) (3) (4) (5) (6)
Present
Value of Present
Periodic Periodic Present $1 at 12% Value of
Standard Variance Value of Squared Variance
Year Deviation Col. (2)2 $1 at 12% Col. (4)2 (3) × (5)
0 0 0 1.000 1.000000 0
1 $14,700 $216,090,000 .893 .797449 $172,320,754
2 14,700 216,090,000 .797 .635209 137,262,313
3 14,700 216,090,000 .712 .506944 109,545,529
4 14,700 216,090,000 .636 .404496 87,407,541
5 14,700 216,090,000 .567 .321489 69,470,558
6 14,700 216,090,000 .507 .257049 55,545,718
7 14,700 216,090,000 .452 .204304 44,148,051
8 14,700 216,090,000 .404 .163216 35,269,345
9 14,700 216,090,000 .361 .130321 28,161,065
10 14,700 216,090,000 .322 .103684 22,405,076
Variance of net present value............................................. $761,535,950

Standard deviation Variance of net

= present value = $761, 535,, 950 = $27, 596
of net present value

(4) Coefficient = Standard deviiation $27, 596

= = 1.633
of variation Expected net present value $16, 895

(5) The probability that the net present value will exceed zero is approximately 73%,
i.e., the 50% area under the curve that is above the mean plus the approximately
23% area under the curve that is below the mean but above zero (determined
µ – X) ÷ σ = ($16,895 – 0)
from the table of Z values in Exhibit 24-8 of the text for (µ
÷ $27,596 = .61σσ, which is about 23% of the total area under the normal curve).
Chapter 24 24-31

P24-11
(1) Expected value of periodic cash flows:
(1) (2) (3) (4) (5)
Contribution Expected Expected
Expected Margin per Value of Value of
Value of Unit (Cash Annual Cash Annual Annual
Annual Inflow Net Inflow Fixed Pretax Net
Sales of Outflow From Sales Cash Cash Inflow
in Units per Unit) (1) × (2) Outflow (3) – (4)
5,000 $18 $90,000 $10,000 $80,000

(1) (2) (3) (4)

Tax
Tax Basis Depreciation Tax
Year (Cost) Rate Depreciation
1 $180,000 .143 $ 25,740
2 180,000 .245 44,100
3 180,000 .175 31,500
4 180,000 .125 22,500
5 180,000 .089 16,020
6 180,000 .089 16,020
7 180,000 .089 16,020
8 180,000 .045 8,100
$180,000

(1) (2) (3) (4) (5) (6)

Expected Expected Expected
Expected Value of Value of Value of
Value of Taxable Tax After-Tax Net
Pretax Net Tax Income Liability Cash Flow
Year Cash Flow Depreciation (2) – (3) (4) × 40% (2) – (5)
0 $(180,000) 0 0 0 $ (180,000)
1 80,000 $25,740 $54,260 $21,704 58,296
2 80,000 44,100 35,900 14,360 65,640
3 80,000 31,500 48,500 19,400 60,600
4 80,000 22,500 57,500 23,000 57,000
5 80,000 16,020 63,980 25,592 54,408
6 80,000 16,020 63,980 25,592 54,408
7 80,000 16,020 63,980 25,592 54,408
8 80,000 8,100 71,900 28,760 51,240
$ 276,000
24-32 Chapter 24

P24-11 (Continued)

Expected value of the periodic standard deviation:

(1) (2) (3) (4) (5)

Pretax After-Tax
Cash Flow Cash Flow
Standard Value of Value of
Deviation Pretax Standard After-Tax Standard
in Units Cash Flow Deviation Portion Deviation
of Sales per Unit (1) × (2) (1 – 40%) (3) × (4)
2,000 $18 $36,000 .6 $21,600

(2) Expected net present value of investment:

(1) (2) (3) (4)

Expected Present
Value of Present Value of
After-Tax Net Value of After-Tax Net
Year Cash Flow $1 at 12% Cash Flow
0 $(180,000) 1.000 $ (180,000)
1 58,296 .893 52,058
2 65,640 .797 52,315
3 60,600 .712 43,147
4 57,000 .636 36,252
5 54,408 .567 30,849
6 54,408 .507 27,585
7 54,408 .452 24,592
8 51,240 .404 20,701
Expected net present value................................. $ 107,499
Chapter 24 24-33

P24-11 (Concluded)

(3) Standard deviation of expected net present value:

(1) (2) (3) (4)

Present
Value of
Periodic Present Standard
Standard Value of Deviation
Year Deviation $1 at 12% (2) × (3)
0 0 1.000 0
1 $21,600 .893 $ 19,289
2 21,600 .797 17,215
3 21,600 .712 15,379
4 21,600 .636 13,738
5 21,600 .567 12,247
6 21,600 .507 10,951
7 21,600 .452 9,763
8 21,600 .404 8,726
Standard deviation of net
present value ..................................................... $107,308

(4) Coefficient = Standard deviation $107,, 308

= = .998
of variation Expected net present value $107, 499

(5) The probability that the net present value will exceed zero is approximately 84%,
i.e., the 50% area under the curve that is above the mean plus the 34% area under
the curve that is below the mean but above zero (determined from the table of Z
µ – X) ÷ σ = ($107,499 – 0) ÷ $107,308 = 1.0σ
values in Exhibit 24-8 of the text for (µ σ,
which is about 34% of the total area under the normal curve.)
24-34 Chapter 24

P24-12

(1) Expected net present value of mixed cash flows:

(1) (2) (3) (4) (5) (6)

Present
Expected Expected Total Value of
Independent Dependent Expected Expected
After-Tax After-Tax After-Tax Net After-Tax Net
Net Cash Net Cash Cash Inflow Present Cash Inflow
Inflow Inflow (Outflow) Value of (Outflow)
Year 70% 30% (2) + (3) $1 at 10% (4) × (5)
0 $(30,000) 1.000 $ (30,000)
1 $5,600 $2,400 8,000 .909 7,272
2 7,700 3,300 11,000 .826 9,086
3 7,000 3,000 10,000 .751 7,510
4 6,300 2,700 9,000 .683 6,147
5 4,900 2,100 7,000 .621 4,347
Expected net present value ............................................................... $ 4,362

(2) Variance and standard deviation of expected net present value:

(1) (2) (3) (4) (5) (6)
Independent Independent Present
Cash Flow Cash Flow Value of Present
Periodic Periodic Present $1 at 10% Value of
Standard Variance Value of Squared Variance
Year Deviation Col. (2) 2 $1 at 10% Col. (4)2 (3) × (5)
0 0 0 1.000 1.000000 0
1 $1,000 $1,000,000 .909 .826281 $ 826,281
2 1,000 1,000,000 .826 .682276 682,276
3 1,000 1,000,000 .751 .564001 564,001
4 1,000 1,000,000 .683 .466489 466,489
5 1,000 1,000,000 .621 .385641 385,641
Variance of expected NPV for independent cash flows................... $2,924,688
Chapter 24 24-35

P24-12 (Concluded)

(1) (2) (3) (4)

Dependent Present
Cash Flow Value of
Periodic Present Standard
Standard Value of Deviation
Year Deviation $1 at 10% (2) × (3)
0 0 1.000 0
1 $500 .909 $ 455
2 500 .826 413
3 500 .751 376
4 500 .683 342
5 500 .621 311
Standard deviation of NPV .................................. $1,897

(
(
Variance of net Standard deviation of 2

present value for = net present value for

dependent cash flows dependent cash flows

= ($1,897)2 = $3,598,609
Variance of NPV for dependent cash flows .................................. $3,598,609
Variance of NPV for independent cash flows ............................... 2,924,688
Variance of total NPV of investment.............................................. $6,523,297

Standard deviation of Variance of total

total net present value = net present value

= $6, 523, 297 = $2, 554

(3) Coefficient = Standard deviation $2, 554

= = 0.586
of variation Expected net present value $4, 362

(4) The probability that the net present value will exceed zero is approximately 96%,
i.e., the 50% area under the curve that is above the mean plus the approximately
46% area under the curve that is below the mean but above zero (determined
µ – X) ÷ σ = ($4,362 – 0)
from the table of Z values in Exhibit 24-8 of the text for (µ
÷ $2,554 = 1.71σσ, which is about 46% of the total area under the normal curve.)
 24-36

P24-13

Based on the results of the MADM worksheet below, Glotyne management should choose the CIM system because
its composite weighted score is higher than the alternative. Based on this analysis, the CIM system is expected to
more adequately satisfy management’s modernization goals.
GLOTYNE CORPORATION
Capital Expenditure Proposal
MADM Worksheet

Relative Modernize With Existing Technology Modernize With New Technology

Importance Performance Likelihood Weighted Performance Likelihood Weighted
Factors Weighting Rating Estimate Score Rating Estimate Score
Net present value .................................... 30 2 .8 48.0 0 .5 0
Reduce setup time................................... 20 0 .5 0 2 .9 36.0
Reduce throughput time ......................... 15 1 .5 7.5 2 .9 27.0
Improve product quality .......................... 15 1 .9 13.5 2 .5 15.0
Reduce inventory levels ......................... 10 0 .9 0 1 .6 6.0
Improve image to outsiders .................... 10 1 .5 5.0 1 .6 6.0
Total........................................................... 100 74.0 90.0
Chapter 24