Question

A firm must decide whether to construct a small, medium, or large stamping plant. A consultant’s report indicates a .20 probability that demand will be low and an .80 probability that demand will be high. If the firm builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium-size facility as a hedge: If demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be −$20 million, whereas high demand will result in a net present value of $72 million. b. What is the maximin alternative? (Negative amount should be indicated by a minus sign. Omit the "$" sign in your response.)

Answer 1

Answer:

EV(1) = max(46.8, 44.4, 53.6) = 53.6m

Explanation:

Diagram is shown in the attached file

EV(5) =max(42, 48) = 48m

EV(6) =max(46, 50) = 50m

EV(2) =0.20(42) + 0.80(48) = 46.8m

EV(3) =0.20(22) + 0.80(50) = 44.4m

EV(4) =0.20(-20) + 0.80(72) = 53.6m

EV(1) =max(46.8, 44.4, 53.6) = 53.6m