Philip Musa can build either a large video rental section or a small one in his
ID: 3120003 • Letter: P
Question
Philip Musa can build either a large video rental section or a small one in his Birmingham drugstore. He can also gather additional information or simply do nothing. If he gathers additional information, the results could suggest either a favorable or an unfavorable market, but it would cost him $ 3,000 to gather the information. Musa believes that there is a 50 50 chance that the information will be favorable. If the rental market is favorable, Musa will earn $ 15,000 with a large section or $ 5,000 with a small. With an unfavorable video- rental market, however, Musa could lose $ 20,000 with a large section or $ 10,000 with a small section. Without gathering additional information, Musa estimates that the probability of a favorable rental market is .7. A favorable report from the study would increase the probability of a favorable rental market to .9. Furthermore, an unfavorable report from the additional information would decrease the probability of a favorable rental market to .4. Of course, Musa could ignore these numbers and do nothing. What is your advice to Musa?
Explanation / Answer
Here expected earning in case of making large rental market by gathering additional information
=0.5(0.9 x 15000 + 0.1(-20000)+0.4(15000)+0.6(-20000)) - 3000
(It is because 0.1 and 0.4 are probability of unfavorable rental market that we get subtracting pro. of favorable case from 1)
=0.5 ( 13500-2000 +6000-12000)- 3000
=0.5 x 5500 - 3000 = -250
Or he is in loss of $250.
Now Here expected earning in case of making large rental market without gathering additional information
=0.7 x 15000 +0.3(-20000)= 10500 - 6000 = $4500
Or in this case, he is in profit of $4500
Further, his expected earning in making small rental market with addition information
=0.5(0.9 x 5000 + 0.1(-10000)+0.4(5000)+0.6(-10000)) - 3000
=0.5(4500 -1000 +2000 - 6000)-3000
=0.5 x (-500)-3000 = -3250
Or in such setup, he is in loss of $3250.
his expected earning in making small rental market without addition information
=0.7( 5000)- 0.3( 10000) = 3500 - 3000 = $ 500
or he is in profit of $500
So it is suggested, that Musa should setup a large rental market without gathering information so that to earn maximum profit there.
Answer