Reference no: EM133979021

Question

The Pulsometer Pump Company makes concrete pumping equipment for the European market and is at present operating at near production capacity. The sales and marketing director of the company anticipates that the market for concert pumps will increase by 15% during the next twelve months. The board must decide how to react to this change in demand. There are three strategies that are being considered

S1 Install new equipment to improve productivity with a new system of working
S2 Institute overtime and weekend working
S3 Continue to work at capacity and let rivals or new firms satisfy the increased demand.

A decision matrix can be constructed to show information (all columns show profits, in £000s).

Market Factors
Strategy 15% Stable -10%
S1 240 130 0
S2 210 150 70
S3 170 150 70

Use the Pay-off Matrix to make decision and inform what decisions should the board take? The company board satisfied with pay-off procedure however they are not confident with your decision. The sales and marketing director of the company now decided that "we need the probabilities associated with the change in market demands". The probabilities are

Market Outcomes Probability (in %)

15% Rise 0.6
Stable 0.3
10% fall 0.1

Calculate the Expected Monetary Value Analysis (EMV) for each strategy and use decision tree to show the best option. The board are impressed with decision method which has informed their decision making. They have assigned you to further investigation on the decision due to variability of returns and further measure of the degree of risk. You need support to do further investigation so that you can examine the sensitivity of decisions. A firm of consultants offer to survey the market for concrete pumps. This survey will lead to a revision of prior probabilities estimate of the likely market outcome. The survey will cost the company £5,000. The consultancy predictions records are shown below

Consultant`s Prediction (in %)
Actual Market Outcome Prior
Probabilities Rise Stable Fall
Raise 0.6 0.7 0.2 0.1
Stable 0.3 0.2 0.6 0.2
Fall 0.1 0.1 0.2 0.7

Hint: The sum of getting a `Raise report` is given by the sum of the probabilities of getting a `Raise report` under each outcome multiplied respectively by the probability of getting that outcome.

Use the Bayes Theorem to revise the consultant`s prediction. Should you choose to pay for this additional information? Produce a revised Decision tree for the board to make a decision. You should discuss on your decision on to use or not to use the consultant firm and each strategy.

Part 1-Outcomes

Introduction to problem

Pay-off matrices, decision and discussion
EMV, Decision Tree and Discussion
Bayes Theorem, step-by-step calculation, post probabilities table and discussion
Each strategy probability and Decision tree
Final Decision