Subject: OPERATIONS MGMT in Business

9. A firm must decide whether to construct a small, medium, or large stamping plant. A consultantsreport indicates a .20 probability that demand will be low and an .80 probability that demand willbe high.If the firm builds a small facility and demand turns out to below, 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 presentvalue is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realizea 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.

a. Analyze this problem using a decision tree.

b. What is the maximin alternative?

c. Compute the EVPI and interpret it.

d. Perform sensitivity analysis on P (high).