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Use of Expected Profit Method to determine optimal bid

1. Gamma construction company has been asked to bid on the construction of 20 lighted tennis courts for State university. Each court will cost $20,000 in construction costs, and, in addition, there will be a fixed expense of $10,000 to cover the preparation and submittal of the bid. Gamma is considering five different bid levels. Each involves a different profit margin, calculated as a percentage above total construction cost (TCC). Fixed expenses are excluded from this calculation, but they are relevant for profitability. Based on previous experience, Gamma's management is able to estimate the probability that it will win the bid at each level being considered. The bids and probabilities are summarized below:

Bid number amount of bid Probability of win

1 TCC = 5% 0.80

2 TCC + 10% 0.70

3 TCC + 15% 0.50

4 TCC + 20% 0.30

5 TCC + 25% 0.20

Gamma's objective is to select the bid that maximizes its expected profit.

What is the dollar amount associated with the optimal bid?

Solution Preview

Since solution contains tables. It may not come clear here as text. Pls refer attached document.

Solution on Total Construction Cost
1) What is the dollar amount associated with the optimal bid?

In this problem 10000 is a sunk cost, it is not be included in Total construction ...

Solution Summary

Solution describes the expected profit method to find out the optimal bid. Probabilities of winning the bid are provided.

$2.19