Seneca Hill Winery recently purchased land for the purpose of establishing a new vineyard. Management is considering two varieties of white grapes for the new vineyard: Chardonnay and Riesling. The Chardonnay grapes would be used to produce a dry Chardonnay wine, and the Riesling grapes would be used to produce a semi-dry Riesling wine. It takes approximately four years from the time of planting before new grapes can be harvested. This length of time creates a great deal of uncertainty concerning future demand and makes the decision concerning the type of grapes to plant difficult. Three possibilities are being considered: Chardonnay grapes only, Riesling grapes only, and both Chardonnay and Riesling grapes. Seneca management decided that for planning purposes it would be adequate to consider only two demand possibilities for each type of wine: strong or weak. With two possibilities for each type of wine it was necessary to assess four probabilities. With the help of some forecasts in industry publications, management made the following probability assessments.
(see attached chart)
Revenue projections show an annual contribution to profit of $20,000 if Seneca Hill only plants Chardonnay grapes and demand is weak for Chardonnay wine, and $70,000 if it only plants Chardonnay grapes and demand is strong for Chardonnay wine. If it only plants Riesling grapes, the annual profit projection is $25,000 if demand is weak for Riesling grapes and $45,000 if demand is strong for Riesling grapes. If Seneca plants both types of grapes, the annual profit projections are shown in the following table.
(see attached chart)
a. Develop a decision tree or a complete payoff table to represent the alternatives and outcomes for this problem.
b. Use the expected value approach to recommend which alternative Seneca Hill Winery should follow in order to maximize expected annual profit.
c. Suppose management is concerned about the probability assessments when demand for Chardonnay wine is strong. Some believe it is likely for Riesling demand also to be strong in this case. Suppose the probability of strong demand for Chardonnay and weak demand for Riesling is 0.05 and the probability of strong demand for Chardonnay and strong demand for Riesling is 0.40. How does this change the recommended decision? Assume that the probabilities when Chardonnay demand is weak are still 0.05 and 0.50.
d. Other members of the management team expect the Chardonnay market to become saturated at some point in the future, causing a fall in prices. Suppose that the annual profit projections fall to $50,000 when demand for Chardonnay is strong and Chardonnay grapes only are planted. Using the original probability assessment, determine how this change would affect the optimal decision.
This solution is comprised of a detailed explanation to develop a decision tree or a complete payoff table to represent the alternatives and outcomes for this problem.