The Oahu Trading Company is considering the purchase of a small firm that produces clocks. Oahu's management feels there is a 50-50 chance, if Oahu buys the firm, that it can mold the firm into an effective producer of washing machine parts. If the firm can be transformed in this way, Oahu believes that it will make $500,000 if it buys the firm; if it cannot be transformed in this way, Oahu believes that it will lose $400,000.
a. Construct a decision tree to represent Oahu's problem.
b. What are the decision forks? (Are there more than one?)
c. What are the chance forks? (Are there more than one?)
d. Use the decision tree to solve Oahu's problem. In other words, assuming that the firm wants to maximize the expected profit, should Oahu buy the firm?
e. Before Oahu makes a decision concerning the purchase of the firm, Oahu's president learns that if the clock producer cannot be made into an effective producer of washing machine parts, there is a 0.2 probability that it can be resold to a Saudi Arabian syndicate at a profit of $100,000.
(If the firm cannot be resold, Oahu will lose $400,000.)
(1) Does this information alter the decision tree?
(2) Can you think of three mutually exclusive outcomes if Oahu buys the firm?
(3) What is the probability of each of these outcomes?
(4) What is the monetary value to Oahu of each of these outcomes?
f. Use your results in part (e) to solve Oahu's problem under this new set of conditions. In other words, on the basis of this new information, should Oahu buy the firm?
g. Oahu's executive vice president discovers an error in the estimate of how much Oahu will gain if it buys the clock manufacturer and turns it into an effective producer of washing machine parts.
(1) Under the circumstances in part (d), how big would this error have to be to reverse the indicated decision?
(2) Under the circumstances in part (e), ho