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Decision trees and EMV

It is projected that a needed item will sell for $10 each. If the item is outsourced, there is virtually no cost other than the $5 per unit that they would pay their supplier.

Process A requires an investment of $120,000 for design and equipment, but results in a $6 per unit cost.

Process B requires only a $100,000 investment but is per unit cost is $5.

Regardless of whether the item is subcontracted or produced internally, there is a 50% chance that they will sell 50,000 units, and a 50% chance that they will sell 100,000 units.

Using the decision trees and EMV, what is their best choice?

A. The company only has to choose among three alternatives
B. The decision should be based on which alternative yields the highest profits
C. Process A is preferable to process B
D. Process A promises the highest profits

There could be more than one correct answer.

Solution Preview

Expected No of Units sold = 50% x 50,000 + 50% x 100,000 = 75,000 units

Outsourcing Option:

Total Profit per unit if outsourced = $10 - $5 = ...