Ad vanced : Expected value comparison of low and high pri ce alternatives The research and development
Question:
Ad vanced : Expected value comparison of low and high pri ce alternatives The research and development department of Shale White has produced specifications for two new products for consideration by the company's production director. The director has received detailed costings which can be summarized as follows:
The sales department has provided estimates of the probabilities of various levels of demand for two possible selling prices for each product. The details are as follows·
It would be possible to adopt the low price alternative for product newone together with the high price alternative for newtwo, or the high price alternative for product newone with the low price alternative for newtwo (demand estimates are independent for the two products).
The factory has 60 000 machine hours available during the year.
For some years past it has been working at 90% of practical capacity making a standardized product. This product is very profitable and it is only the availability of 6000 hours of spare machine capacity that has made it necessary to search for additional product lines to use the machines fully. The actual level of demand will be known at the time of production.
A statistical study of the behav1our of the factory overhead over the past year has indicated that it can be regarded as a linear function of factory machine lime worked. The monthly fixed cost1s estimated at £10000 and the variable cost at £1 per machine hour with a coefficient of correlation of 0.8.
You are required:
(a) to identify the best plan for the utilization of the 6000 machine hours, to comment on the rational selling price alternatives that exist for this plan and to calculate the expected increase 1n annual profit which would arise for each alternative. (17 marks)
(b) to discuss the relevance of regress1on analysis for problems of this type.
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