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Decision Tree and Optimal Decision Making

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You are faced with a decision what size to build a production facility. You are given four choices:

1. Do not build a production plant. This will not cost any money and will not generate any profit.
2. Build a large sized production facility. This will generate a profit of $12 million in a favorable market and lose $8 million in an unfavorable market.
3. Build a medium sized production facility. This will generate a profit of $10 million in a favorable market and lose $2 million in an unfavorable market.
4. Build a small sized production facility. This will generate a profit of $5 million in a favorable market and lose $1 million in an unfavorable market.
There is a 70% chance of a favorable market and a 30% chance of an unfavorable market.

a) Draw a decision tree for the above and compute the expected returns for each branch of the decision tree.

b) Determine the optimal strategy (what size facility to build if any) and its EMV. (10 points)

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