Myrtle Air Express decided to offer direct service from Clev

Myrtle Air Express decided to offer direct service from Cleveland to Myrtle Beach. Management must decide between a full-price service using the company’s new fleet of jet aircraft and a discount service using smaller capacity commuter planes. It is clear that the best choice depends on the market reaction to the service Myrtle Air offers. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service to Myrtle Beach: strong and weak. The following table shows the estimated quarterly profits (in thousands of dollars):

Demand for Service

1. If nothing is known about the probabilities of the chance outcomes, what is the recommended decision using the pessimistic and minimax regret approaches?

2. Suppose that the management of Myrtle Air Express believes that the probability of strong demand is 0.7 and the probability of weak demand is 0.3. Use the expected value approach to determine an optimal decision. (Provide the expected value for each service.)

3. What is the EVPI given the information in part (2)?

Solution

1.The pessimistic and minimax regret approaches is to find an optimal decision, for each state of nature. Determine the best payoff over all decisions. Calculate the regret for each decision alternative as the difference between its payoff value and this best payoff value.

2. Given that he probability of strong demand is 0.7 and the probability of weak demand is 0.3

Expected value of Full price (FP) is

E(FP)=0.7*960+0.3*(-490)=$525

Expected value of discount (dis) is

E(dis)=0.7*670+0.3*320=$565

3. EVPI means expected value of perfect information

EVPI=|EVwPI-EVwoPI|

EVwPI means expected value with perfect information about the states of nature

EVwoPI means expected value without perfect information about the states of nature

EVwPI=670*0.7-490*0.3=$322

EVeoPI=525

EVP!=|322-525|=$203