The Steiner-Wallace Corporation has determined that it needs to expand in order to accommodate growing demand for its laptop computers. The decision has come down to either expanding now with a large facility, incurring additional costs and taking the risk that the demand will not materialize, or expanding small, knowing that in three years management will need to reconsider the question.
Management has estimated the following chances for demand:
The likelihood of demand being high is 0.60.
The likelihood of demand being low is 0.40.
Profits for each alternative have been estimated as follows:
Large expansion has an estimated profitability of either $100,000 or $60,000, depending on whether demand turns out to be high or low.
Small expansion has a profitability of $50,000, assuming that demand is low.
Small expansion with an occurrence of high demand would require considering whether to expand further. If the company expands at that point, the profitability is expected to be $70,000. If it does not expand further, the profitability is expected to be $45,000.
(a) Draw a decision tree showing the decisions, chance events, and their probabilities, as well as the profitability of outcomes.
(b) Solve the decision tree and decide what Steiner-Wallace should do.