If he feels the chances of low, normal, and high precipitation are 30 percent, 20 percent, and 50 percent respectively, What is EVPI (Expect

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If he feels the chances of low, normal, and high precipitation are 30 percent, 20 percent, and 50 percent respectively, What is EVPI (Expected value of Perfect Information)?

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Linh Đan 5 years 2021-09-02T20:32:13+00:00 1 Answers 40 views 0

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  1. Maris
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    2021-09-02T20:34:06+00:00
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    Question:

    The operations manager for a well-drilling company must recommend whether to build a new facility, expand his existing one, or do nothing. He estimates that long-run profits (in $000) will vary with the amount of precipitation (rainfall) as follows:

    Alternative             Precipitation                                

                            Low                Normal                 High

    Do nothing    -100                       100                    300

    Expand           350                       500                   200

    Build new       750                       300                    0

    If he feels the chances of low, normal, and high precipitation are 30 percent, 20 percent, and 50 percent respectively, What is EVPI (Expected value of Perfect Information)?

    A. $140,000

    B. $170,000

    C. $285,000

    D. $305,000

    E. $475,000

    Answer:

    D. $170,000

    Explanation:

    The expected long run profits are  for

                            Low                Normal                 High

    Do nothing    -100*0.3                100*0.2                   300*0.5 = 140

    Expand           350*0.3                500*0.2                  200*0.5 = 305

    Build new       750*0.3                300*0.2                  0*0.5    = 285

    Therefore the expected long run profits are

    $140,000

    $305,000

    $285,000

    Based on his selected option being either to build new or to expand, the most profitable option is to expand

    =$305,000

    EVPI = EPPI-EMV =$170,000

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