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Posted: February 1st, 2024

What is the expected value of perfect information in Operation Management

What is the expected value of perfect information in Operation Management

The owner of a landscaping company is considering what to do with her company over the next two years. The last couple of years, her business has experienced a substantial increase in demand. Lately, however, there has been talk of a developer planning to build a large industrial park in the county. The landscaping company owner forecasts that potential service contracts with the new industrial park complex will increase her demand. To be prepared for the opportunities if the industrial park is built, the owner sees three options for her company: the first is to undertake a one-time major expansion of her business, the second is to commit to a minor expansion this year and another minor expansion in the second year, the third option is to simply wait and do nothing. The probability that the developer will build the industrial park is estimated at about 0.30. The assumptions and conditions are summarized below.

a. With a major expansion will result in two-year service revenues of $300,000 if the industrial park is built and $100,000 if it is not built.

b. A two-year commitment to two minor expansions will result in two-year service revenues of $250,000 if the industrial park is built and $100,000 if it is not built.

c. Waiting and doing nothing will result in service revenues of $100,000 whether or not the industrial park is built. The owner would like to determine the best alternative action.

d. Develop the appropriate pay off table.

e. Draw the decision tree.

f. Which alternative has the highest expected monetary value (EMV) under risk, and therefore would be the best alternative?

g. What is the expected value with perfect information (EVwPI)?

h. What is the expected value of perfect information (EVPI)?

i. If the cost of a major expansion is $70,000, and the total cost of two minor expansions is $90,000, what would be the EP (expected payoff or profit) for each alternative? Given this new information, which alternative would be the best?

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