Purchase Solution

# Buying a new manufacturing system

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Company A faces the decision of buying a new flexible manufacturing system or keeping the current system. Management projections for the cash flows are given below under two demand scenarios: H (high demand) and L (low demand). This information is summarized in the following table.

H(0.5) L(0.5)
Old System \$35M \$17.5M
FMS \$45M \$13M

1. To compute the expected value of each alternative and the Expected value under perfect
information.

Old System = 35*0.5 + 17.5*0.5 = 26.25
FMS = 45*0.5 + 13*0.5 = 29

Is this correct?

What is the maximum expected value of additional information?

2. Company A considering the advisability of undertaking a study, which will make a
prediction on demand, at a cost of \$2M. Company A's assessment of confidence in the
study is summarized by the conditional probabilities of the prediction, h (high) or l(low),
given the state of nature H or L. These probabilities are: P(h|H) = 0.7, P(h|L) =
0.2, P(l|H) = 0.3 and P(l|L) = 0.8.

Based on this info, how do I compute the posterior probabilities under each prediction, and determine if the study should be undertaken?

##### Solution Summary

A new manufacturing system for buying is determined. The maximum expected value of additional information is computed.

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Company A faces the decision of buying a new flexible manufacturing system or keeping the current system. Management projections for the cash flows are given below under two demand scenarios: H (high demand) and L (low demand). This information is summarized in the following table.

H(0.5) L(0.5)
Old System \$35M \$17.5M
FMS \$45M \$13M

1. To compute the expected value of each alternative and the Expected value under perfect
information.

Old System = 35*0.5 + 17.5*0.5 = 26.25
FMS = 45*0.5 + 13*0.5 = 29

Is this correct?This is correct.

EVPI = .5*45 + .5*17.5 = 31.25 ( when u know Demand will be high u will install new ...

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