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Capacity Planning

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Spectrum Hair Salon is considering expanding its business, as it is experiencing a large growth. The question is whether it should expand with a bigger facility than needed, hoping that demand will catch up, or with a small facility, knowing that it will need to reconsider expanding in three years. The management at Spectrum has estimated the following chances for demand:

the likelihood of demand being high is 0.70;

the likelihood of demand being low is 0.30.

Estimated profits for each alternative are as follows:

large expansion has an estimated profitability of either $100,000 or $70,000, depending on whether demand turns out to be high or low;

small expansion has a profitability of $50,000, assuming that demand is low;

small expansion with an occurrence of high demand would require considering whether to expand further. If the business expands at this point, the profitability is expected to be $90,000. If it does not expand further, the profitability is expected to be $60,000.

Draw a decision tree showing the decisions, chance events, and their probabilities, as well as the profitability of outcomes, and solve the decision tree

EVsmall expansion = $, EVlarge expansion = $

What should Spectrum do?

Company should opt for the small large expansion now.

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