Calculate EVPI (2 Questions: Multiple Choice and Fill in the Blank)

QUESTION 1
Myrtle Air Express decided to offer direct service from Cleveland to Myrtle Beach. Management must decide between a full-price service using the company’s new fleet of jet aircraft and a discount service using smaller capacity commuter planes. It is clear that the best choice depends on the market reaction to the service Myrtle Air offers. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service to Myrtle Beach: strong and weak. It is estimated that the quarterly profits are $960,000 (strong demand) and -$490,000 (weak demand) if a full-price service is offered, and $670,000 (strong demand) and $320,000 (weak demand) if discount service is offered.

A. If nothing is known about the probabilities of the chance outcomes, what is the recommended decision using the optimistic, conservative, and minimax regret approaches?
Recommended decision based on the optimistic approach: ________ (enter F for full price service and D for discount service)
Recommended decision based on the conservative approach:_______ (enter F for full price service and D for discount service)
Recommended decision based on the minimax regret approach: ________(enter F for full price service and D for discount service)

B. Suppose that management of Myrtle Air Express believes that the probability of strong demand is 0.7 and the probability of weak demand is 0.3. What is the recommended decision based on the EMV rule? ________   (enter F for full price service and D for discount service)

What is the expected profit $________  (in dollars, to 0 decimals)

C. Based on the management’s probabilities, calculate EVPI =________  (in dollars, to 0 decimals)

QUESTION 2
The Lake Placid Town Council has decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area, but the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst case, base case, and best case. The worst-case scenario corresponds to a situation in which tourism drops significantly; the base-case scenario corresponds to a situation in which Lake Placid continues to attract visitors at current levels; and the best-case scenario corresponds to a significant increase in tourism. The consultant has provided probability assessments of .10, .60, and .30 for the worst-case, base-case, and best-case scenarios, respectively.
The town council suggested using net cash flow over a five-year planning horizon as the criterion for deciding on the best size. A consultant developed the following projections of net cash flow (in thousands of dollars) for a five-year planning horizon. All costs, including the consultant’s fee, are included.

Demand Scenario

Center Size
Worst Case
Base Case
Best Case

Small
400
500
660

Medium
-250
650
800

Large
-400
580
990

 
A. Show the expected net cash flow (in thousands of dollars) for each decision alternative (to the nearest whole number).

Small Center

Medium Center

Large Center

What is your recommended decision?  (enter 1, 2, 3, 4, or 5)

Small center
Medium center
Larger center
Either the small or medium center
Either the medium or larger center

 
B. What is the expected value of perfect information (in thousands of dollars)? 
Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur?  (enter 1 or 2)

Yes, the value of perfect information suggests a market research study could be beneficial
No, the value of perfect information shows little to be gained by further study

 
C. Suppose the probability of the worst-case scenario increases to 0.20, the probability of the base-case scenario decreases to 0.50, and the probability of the best-case scenario remains the same. Show the expected net cash flow (in thousands of dollars) for each decision alternative (to the nearest whole number).

Small Center

Medium Center

Large Center

What is your recommended decision?  (enter 1, 2, 3, 4, or 5)

Small center
Medium center
Larger center
Either the small or medium center
Either the medium or larger center

 
D. The consultant suggested that an expenditure of $150 thousand on a promotional campaign will effectively reduce the probability of the worst-case scenario to zero and increase the probability of the best-case scenario to 0.40. The probability of the base-case scenario will be 0.60. Include the cost of the promotional campaign and show the revised projections of the net cash flow (in thousands of dollars).

Base Case
Best Case

Small Center

Medium Center

Large Center

Using this payoff table, show the expected net cash flow (in thousands of dollars) for each decision alternative (to the nearest whole number).

Small Center

Medium Center

Large Center

What is your recommended decision?  (enter 1, 2, 3, 4, or 5)

Small center
Medium center
Larger center
Either the small or medium center
Either the medium or larger center