Problem 13-07 (Algorithmic) Hudson Corporation is considering three options for
ID: 418773 • Letter: P
Question
Problem 13-07 (Algorithmic)
Hudson Corporation is considering three options for managing its data processing operation: continuing with its own staff, hiring an outside vendor to do the managing (referred to as outsourcing), or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows:
If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data processing operation?
What is the expected annual cost associated with that recommendation? If rerequired, round your answer to the nearest dollar.
Expected annual cost = $
Construct a risk profile for the optimal decision in part (a).
What is the probability of the cost exceeding $700,000? If required, round your answer to two decimal places.
Probability =
Explanation / Answer
1. The payoff values for different options.
Own staff = 0.2x650+0.5x650+0.3x600 = 130+325+180 =635
Outside vendor = 0.2x900+0.5x600+0.3x300 =180+300+90 =570
Combination = 0.2x800+0.5x650+0.3x500 = 160+325+150 =635
Lowest cost of 570 corresponds to the outside vendor.
Expected annual cost = $570000
Risk profiel for the optimal decision
probability of cost exceeding 800 in the chosen alternative corresponds to high demand ( prob 0.2 of having a cost 900000, which is the only scenario of cost higher than 700000). Hence the required probability is 0.2.
Cost Probability 900 0.2 600 0.5 300 0.3 570 1