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Expected Value Criteria Decision Analysis

FAVORABLE UNFAVORABLE
MARKET MARKET
EQUIPMENT: ($) ($)
Sub 100 300,000 -200,000
Oiler J 250,000 -100,000
Texan 75,000 -18,000

3-19 The Lubricant is an expensive oil newsletter to which many oil giants subscribe, including Ken Brown (see Problem 3-17 for details, table provided above). In the last issue, the letter described how the demand for oil products would be extremely high. Apparently, the American consumer will continue to use oil products even if the price of these products doubles. Indeed, one of the articles in the Lubricant states that the chances of a favorable market for oil products was 70%, while the chance of an unfavorable market was only 30%. Ken would like to use these probabilities in determining the best decision.

(a) What decision model should be used?
(b) What is the optimal decision?
(c) Ken believes that the $300,000 figure for the Sub 100 with a favorable market is too high. How much lower would this figure have to be for Ken to change his decision made in part (b)?

Solution Preview

A) What decision model should be used?

In the probabilistic model, he should use Expected Value criteria.

B) What is the optimal decision?

EQUIPMENT FAVORABLE MARKET ($) UNFAVORABLE MARKET ($)
Sub 100 300,000 -200,000
Oiler J 250,000 -100,000
Texan 75,000 -18,000

Probability of favorable market=70%=0.70
Probability of unfavorable ...

Solution Summary

Solution chooses the best equipment by using expected value approach.

$2.19