ABC Inc must make a decision on its current capacity for nex

ABC Inc. must make a decision on its current capacity for next year. ABC is considering three alternatives. For each alternative, estimated profits (in $000s) based on next year’s demand are shown in the table below. ABC Inc. estimates that the probability of low demand is 0.4 and the probability of high demand is 0.6.

.a True of False. Alternative 2 (A2) dominates Alternative 3 (A3).

.b Which alternative should be chosen based on the optimistic (maximax) decision criterion?

.c Which alternative should be chosen based on the conservative (maximin) decision criterion? 4.4.d (0.3 pt) Construct the regret table. What is the maximum regret if ABC chooses A1. [Give a numerical answer in $.]

.e Which alternative should be chosen based on the minimax regret criterion?

.f Which alternative should be chosen using the expected monetary value criterion?

Solution

a.

Expected profit for A2 = 0.4*125+0.6*175 = 155

Expected profit for A3 = 0.4*120+0.6*147 = 136.2

Thus the alternative A2 dominates A3 . Hence the given statement is true.

b.

Thus using the Maximax criteria Alternative 1 which is to expand should be chosen.

c.

Thus using the maximin criteria Alternative 2 A2 should be chosen.

d.

The maximum regret if ABC choses A1 will be $192,000

e.

Thus using the minimax regret criterion Alternative 3 A3 should be chosen.

f.

Expected return for A1 = 0.4*97+0.6*192 = 154

Expected return for A2 = 0.4*125+0.6*175 = 155

Expected return for A3 = 0.4*120+0.6*147 = 136.2

Thus using expected monetary value criterion A2 should be chosen.