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Decision Tree Analysis

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Harvey Publishing Company, a small publisher in Columbus, is considering a new book. Typesetting and related costs to prepare for the production are $10,000. It will cost $2 per copy to produce the book. If additional copies are needed at a later time, the set-up cost will be$5,000 and the cost per copy will again be $2. The book will sell for $14 a copy. Royalties, commissions, shipping costs, and so on will be $4 a copy. If the book gets good reviews, it can be expected to sell 5,000 copies a year for 3 years. If it gets bad reviews, sales will be 2000 copies in the first year and will then cease. There is a 0.3 probability of a favorable review. Sally Harvey, president, faces a choice between ordering an immediate production run of 15,000 copies or a production run of 5,000 copies, followed by an additional production runs at the end of the first year if the book is successful. All production runs must be in increments of 5,000 copies. Harvey uses a 10% required return for evaluating new investments. She will pay no taxes because of previous losses and her capital is very limited. Use decision tree analysis to recommend a production schedule and decide whether to publish the book.

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Solution Summary

Uses decision tree analysis to recommend a production schedule and decide whether to publish the book.

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Statistics using decision tree analysis for potential loss to Caribbean bank in hurricane

Q-7a. The management of a bank in the Caribbean was concerned about the potential loss that might occur in the event of a hurricane. The bank estimated that the loss from one of these storms could be as much as $100 million including losses due to interrupted service and customer relations. One project the bank is considering is the installation of an emergency power generator at its operations headquarters. The cost of the emergency generator is $800,000, and if it is installed no losses from this type of storm will be incurred. However, if the generator is not installed, there is a 10% chance that a power outage will occur during the next year. If there is an outage there is a 5% probability that the resulting losses will be very large or approximately $80 million in lost earnings. Alternatively, it is estimated that there is a 95% probability of only slight losses of around $1 million. Using decision tree analysis, determined whether the bank should install the new power generator.

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