BM2108

RISK AND UNCERTAINTY IN DECISION MAKING – Part 1

Case 1: Expected Values

Mr. X has a factory whose monthly capacity is to produce 1,200 units of product X. The demand from regular
customers is risky and is as follows:

Monthly Demand P
400 20%
500 60%
700 20%
100%

Regular customers generate P5 per unit. To maximize the unutilized capacity, Mr. X has the opportunity to
enter into a fixed contract. There are three (3) options for this fixed contract: 500 units, 700 units, and 900
units. For the fixed contract, ABC will generate a contribution margin of P3 per unit.

Required: Prepare the expected value table and calculate the expected value for each special contract.
Using Expected Values, what is the optimal level of special contract must Mr. X commit to maximize profits?

SPECIAL CONTRACT
D P 500 700 900
400 20% 3,500 4,100 4,200
500 60% 4,000 4,600 4,200
6000 20% 5,000 4,600 4,200
100% 4,100 4,500 4,200

The highest EV among the three (3) option is a 700-unit Special Contact, which would yield an EV of 4,500.

Case 2: Maximin
Using the same information as Case 1, if Mr. X uses the maximin approach, what special contract must Mr. X
commit each month?

SPECIAL CONTRACT
D P 500 700 900
400 20% 3,500 4,100 4,200
500 60% 4,000 4,600 4,200
6000 20% 5,000 4,600 4,200
100% 4,100 4,500 4,200

Therefore, Mr. X must choose the 900-units contract.

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https://www.coursehero.com/file/186870865/ManRep-07-Task-Performance-1pdf/
 Case 3: Maximax
Using the same information as Case 1, if Mr. X uses the maximax approach, what special contract must Mr. X
commit each month?

SPECIAL CONTRACT
D P 500 700 900
400 20% 3,500 4,100 4,200
500 60% 4,000 4,600 4,200
6000 20% 5,000 4,600 4,200
100% 4,100 4,500 4,200

Therefore, Mr. X must choose the 500-units contract.

Case 4: Minimax regret

Using the same information as Case 1, if Mr. X uses the Minimax Regret approach, what special contract must
Mr. X commit each month?

SPECIAL CONTRACT
D P 500 700 900
400 20% 700 100 -
500 60% 600 - 400
6000 20% - 400 800

Therefore, Mr. X must choose a 700-units contract.

Case 5: Value of Perfect information

Using the same information as Case 1, Mr. X was approached by a market research company that claims that
their survey results will give perfect information to enable Mr. X to determine the demand from its regular
customers a month before accepting the special order.

Required: What is the maximum amount that Mr. X should pay for the

survey? EV of no perfect information = 4,500 (700) units

EV of perfect information = 4,200 x 20% + 4,600 x 60% + 5,000 x 20%
= 840 +2,760 + 1,000
= 4,600
VOPI = 4,600 - 4,500 = 100

The maximum amount that Mr. X should pay for the survey is 100.

This study source was downloaded by 100000878909998 from CourseHero.com on 01-13-2024 22:38:45 GMT -06:00

https://www.coursehero.com/file/186870865/ManRep-07-Task-Performance-1pdf/