F.J. Brewerton Retailers, Inc., must decide whether to build a small or a large facility at a
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If a small facility is build and demand proves to be low, then there is no option to expand and the payoff is $200,000. If a large facility is build and demand proves to be low, Brewerton then has the option of stimulating demand through local advertising. If he does not exercise this option, then the payoff is $40,000. If he does exercise the advertising option, then the response to advertising will either be modest or sizable, with probabilities of 0.3 and 0.7, respectively. If the response is modest, the payoff is $20,000. If it is sizable, the payoff is $220,000. Finally, if a large facility is build and demand proves to be high, then no advertising is needed and the payoff is $800,000.
(a) What should Brewerton do to maximize his expected payoff?
(b) What is the value of this expected payoff?
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