A manager is trying to decide whether to build a small, medium, or large facility. Demand can be low, average, or high, with the estimated probabilities being

0.25,

0.40,

and

0.35,

respectively.

A small facility is expected to earn an after-tax net present value of just

$12,000

if demand is low. If demand is average, the small facility is expected to earn

$15,000;

it can be increased to medium size to earn a net present value of

$30,000.

If demand is high, the small facility is expected to earn

$50,000

and can be expanded to medium size to earn

$80,000

or to large size to earn

$155,000.

A medium-sized facility is expected to lose an estimated

$25,000

if demand is low and earn

$90,000

if demand is average. If demand is high, the medium-sized facility is expected to earn a net present value of

$100,000;

it can be expanded to a large size for a net payoff of

$125,000.

If a large facility is built and demand is high, earnings are expected to be

$160,000.

If demand is average for the large facility, the present value is expected to be

$80,000;

if demand is low, the facility is expected to lose

$80,000.

Part 2

Choose the correct decision tree below. Note that each payoff is given in thousands ($000).

A.

Expand to lrg

Do nothing

Expand to lrg

Expand to med

Do nothing

Expand to med

Do nothing

$160

$80

$80

$125

$100

$90

$25

$155

$80

$50

$30

$15

$12

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Large

Small

Med

1567234

x y graph

B.

Expand to lrg

Do nothing

Expand to lrg

Expand to med

Do nothing

Expand to med

Do nothing

$160

$80

$80

$125

$100

$90

$25

$155

$80

$50

$30

$15

$12

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Large

Small

Med

1234

x y graph

C.

Expand to lrg

Do nothing

Expand to lrg

Expand to med

Do nothing

Expand to med

Do nothing

$160

$80

$80

$125

$100

$90

$25

$155

$80

$50

$30

$15

$12

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Low 0.25

Avg 0.40

High 0.35

Large

Small

Med

1234