A kitchen appliance manufacturer is deciding whether or not to in- troduce a new product. Management has identified three possible demand regimes, with associated projected income for the first year of operation. In addition, if the company decides to produce the new product, it can do so by using its existing facilities, which will cost it $3,500,000 in renovations; or build a new facility, which will cost $6,500,000. Expanding will allow it to make more product and so its potential sales can be higher. The following table contains a summary of management expectations:

		Demand Regime
	high	medium	low
income with expansion	$17,500,000	$12,250,000	$3,750,000
income with new construction	$45,500,000	$15,250,000	$5,750,000
probability	0.1	0.3	0.6

The company believes that if the new product is not introduced, in the first year of operation the company will loose $10,500,000 in sales to competitors in a high demand regime, $1,500,000 in a medium demand regime, and $0 in a low demand regime.

(a) Construct a payoff table and decision tree for this problem.

(b) Using the expected value approach, what should the company do?

(c) The company finds itself in a difficult financial situation. How does this information affect your recommendation in part (b)?

(d) A consulting company claims it can perform a more thorough market research study. In your opinion, should this study be performed?

(e) The company has the option of constructing a new facility after 1 year of operation. In your opinion, which conditions would warrant an expansion after year 1?

Answer rating: 100% (QA)

a Payoff for each alternative and particular demand regime is calculated by subtracting the cost of ... View the full answer