A small company specializes in assembling and selling electronic health records

Question

A small company specializes in assembling and selling electronic health records systems for use by family doctor practices throughout the country. The company is developing a new cloud-based system which it intends to market under its own brand name next year. At present, company is trying to decide on the manufacturing and assembly process to be used. One aspect of this relates to the keyboard that will be used in the system, which will have specially labelled function keys.

The company faces three alternatives:

• It can manufacture/assemble the keyboard itself

• It can buy the keyboards from a domestic manufacturer

• It can buy the keyboards from an overseas manufacturer.

Each of these options has different costs and benefits. There is uncertainty as to which decision to take because there is uncertainty over future sales. To simplify the situation, company is planning for one of the three possible sales levels in the future: low, medium, high sales. The payoff table for decision alternatives and states of nature combination is provided below.

a) What decision should be made by the conservative decision maker?

b) What decision should be made under minimax regret?

c) What decision should be made by the optimistic decision maker?

d) If the probabilities of low, medium, and high demand are .5, .2, and .4, respectively, then what decision should be made under expected value?

e) Calculate EVPI

Payoff table; profit contributions($000s) Future sales level decision low medium high manufacturer -15 15 50 buy domestic 5 20 40 buy overseas 15 30 25

Explanation / Answer

Ans:

a)Conservative decision maker will use Maximin appproach:

Maximum of respective minimums will be 15,which is paid off from buy overseas option.

b)Minimax regret

Minimum of maximums of respective regrets is 10,which is given from buy domestic option.

c)Optimistic desicion will use Maximax approach:

Maximums of respective maximumus is 50,which is paid off from the manufacturer option.

d)probabilities given are not summing up to 1,so i am considering 0.5,0.2,0.3

Expected monetary value=

Best expected monetary value=21 paid off from buy overseas option.

Best EMV=Expected value without perfect information=21

e)EVPI=expected value with perfect information-expected value without perfect information

Choose the maximum of each scenario, multiply by respective probability and sum up:

Expected value with perfect information=15*0.5+30*0.2+50*0.3=7.5+6+15=28.5

EVPI=28.5-21=7.5

low medium high Minimum manufacturer -15 15 50 -15 buy domestic 5 20 40 5 buy overseas 15 30 25 15

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