Q1 Decision Making Under Risk and Uncertainty

Example: Mr. Sartre

Mr. Sartre runs a market stall selling vegetables and fruits. He buys a product for $20 per case. He can sell the product for $40 per case on his stall.

The product is perishable and it is not possible to store it. Instead any cases unsold at the end of the day can be sold off as scrap for $2 per case.

Purchase orders must be made before the number of sales is known. He has kept records of demand over the last 150 days

Demand Number of days

10 45

20 75

30 30

Required:

1. Prepare a summary of possible daily profit using a payoff table

2. Advise Mr. Sartre.

1. How many cases to purchase if he uses expected values
2. How many cases to purchase if he uses maximin/maximax
3. How many cases to purchase if he uses minimax regret

3. Mr. Sartre has been approached by a research associate to provide him more reliable estimate of his future demand. Advice Mr. Sartre what maximum price he should pay to gain this reliable information.

Q2.

Gam Co. sells electronic equipment and is about to a lunch a new product onto the market. It needs to prepare its budget for the coming year and is trying to decide whether to launch the product at a price of Ghc 30 or Ghc 35 per unit.

The following information has been obtained from market research:

Price per unit Ghc 30 Price per unit Ghc 35

Probability Sales volume Probability Sales volume

0.4 120,000 0.3 108,000

0.5 110,000 0.3 100,000

0.1 140,000 0.4 94,000

Notes:

1. Variable production costs would be Ghc 12 per unit for production volume up to and including 100,000 unit each year. However, if production exceeds 100,000 units each year, the variable production cost per unit would fall to Ghc 11 for all units produced.
2. Advertising costs would be Ghc 90,000 per annum at a selling price of Ghc 30,000 and Ghc 970,000 per annum at a price of Ghc 35
3. Fixed production costs would be Ghc 450,000 per annum.

Required:

1. Calculate each of the six possible profit outcomes which could arise for Gem Co in the coming year.

2. Calculate the expected value of profit for each of the two price options and recommend on this basis which option Gam Co would choose.

3. Briefly explain the maximin decision rule and identify which price should be chosen by management if they use this rule to decide which price should be charged.