Question 2: Problem solving (11 Marks)

Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:

	Outcomes
Alternative Decisions	O1: Favorable Market	O2: Moderate Market	O3: Unfavorable Market
Sub 100	$ 300000	$ 150000	$ -200000
Sub 200	$ 350000	$ 200000	$ 200000
Oil J	$ 250000	$ 100000	$ -100000
Texan	$ 75000	$ 50000	$ 0
Probabilities	0.2	0.5	0.3

For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very pessimistic decision maker.

Questions:

1. What type of decision environment is Ken facing? (1 Mark)

2. What decision criterion should he use? (1 Mark)

3. What alternative is best? (2 Mark)

If information about the probability of each outcome becomes available to Ken then:

Questions:

4. Find the best decision using the adequate technique. (3 Marks)

5. How much Ken should pay to know the perfect information about the market condition? (3 Marks)

6. Is it reasonable for Ken to purchase the perfect information about the market outcomes for $20,000? Explain why. (1 Mark)