Elsatin Limited (EL) has just ventured into a new line of business. To minimise capital expenditure,...

 

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Elsatin Limited (EL) has just ventured into a new line of business. To minimise capital expenditure, the company has decided to hire the plant and machinery required to produce its products. As a result, EL will have to determine the expected level of production capacity required and commit to an annual contract before the start of the operating period. The contract will stipulate the list of plant and machinery hired and this will fix the production capacity of EL for the operating period. EL has a choice of three contracts: Contract Opti, Contract Sensi and Contract Pati. Regardless of the choice of contract, the company will be subject to three states of nature: high demand, medium demand and low demand. The net profits generated by each of the contracts under the three states of nature are as follows: Contract Opti Contract Sensi Contract Pati High demand Probability 48,000 42,000 36,000 The probabilities of the states of nature are as follows: High demand Net profit (£000) Medium demand 30% 35,000 38,000 32,000 Medium demand 50% Low demand 18,000 22,000 28,000 Low demand 20% Number of days matrix Prediction High Prediction - Medium Prediction - Low Contract - Probabilities Opti Sensi Pati High demand High demand £000 24 3 3 12.5% 30 Medium demand 48,000 42,000 36,000 Expected value criterion: Contract Pati Medium demand £000 20.83% 5 40 5 Determine the choice of contract using the expected value criterion if the consultant predicts a low demand 35,000 38,000 32,000 50 Low demand Low demand £000 66.67% 22 18,000 22,000 28,000 16 20 Total 100 (7 marks) 31 45 24 Expected value £000 25,291.1 27,832.8 29,833.2 (4 marks) Elsatin Limited (EL) has just ventured into a new line of business. To minimise capital expenditure, the company has decided to hire the plant and machinery required to produce its products. As a result, EL will have to determine the expected level of production capacity required and commit to an annual contract before the start of the operating period. The contract will stipulate the list of plant and machinery hired and this will fix the production capacity of EL for the operating period. EL has a choice of three contracts: Contract Opti, Contract Sensi and Contract Pati. Regardless of the choice of contract, the company will be subject to three states of nature: high demand, medium demand and low demand. The net profits generated by each of the contracts under the three states of nature are as follows: Contract Opti Contract Sensi Contract Pati High demand Probability 48,000 42,000 36,000 The probabilities of the states of nature are as follows: High demand Net profit (£000) Medium demand 30% 35,000 38,000 32,000 Medium demand 50% Low demand 18,000 22,000 28,000 Low demand 20% Number of days matrix Prediction High Prediction - Medium Prediction - Low Contract - Probabilities Opti Sensi Pati High demand High demand £000 24 3 3 12.5% 30 Medium demand 48,000 42,000 36,000 Expected value criterion: Contract Pati Medium demand £000 20.83% 5 40 5 Determine the choice of contract using the expected value criterion if the consultant predicts a low demand 35,000 38,000 32,000 50 Low demand Low demand £000 66.67% 22 18,000 22,000 28,000 16 20 Total 100 (7 marks) 31 45 24 Expected value £000 25,291.1 27,832.8 29,833.2 (4 marks)

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To determine the choice of contract using the expected value criterion when the consultant predic... View the full answer