Section 5 Applying Expected Monetary Value (EMV) to Capacity Decisions

Section 5 Applying Expected Monetary Value (EMV) to Capacity Decisions 1) Possible decision alternatives found in capacity EMV problems are future demands or market favorability. Answer: FALSE Diff: 2 Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes 2) A retailer is considering building a large store. If the local economy experiences expansion, the firm expects the store to earn a $2,000,000 profit next year. If the local economy experiences a contraction, the firm expects the store to lose $400,000 next year. Analysts estimate a 20% chance for the local economy to experience an expansion next year (hence an 80% chance for contraction). What is the expected monetary value (EMV) of building the large store? A) $1,600,000 B) $720,000 C) $2,000,000 D) $80,000 E) $1,520,000 Answer: D Diff: 2 AACSB: Analytic skills Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes 3) Describe how EMV might be used to analyze a capacity decision. Answer: The EMV for each capacity decision (perhaps large, medium, and small plants) can be evaluated for unknown costs/revenue/other conditions. Each possible scenario (perhaps low, medium, and high demand) is given a payoff value and a probability. The weighted results of these various states of nature sum to the EMV for each capacity decision. An operations manager can then choose the highest EMV to maximize profit or the lowest EMV to minimize costs. Diff: 3 AACSB: Reflective thinking skills Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes S7-24 4) A firm is weighing three capacity alternatives: small, medium, and large job shop. Whatever capacity choice is made, the market for the firm's product can be "moderate" or "strong." The probability of moderate acceptance is estimated to be 40 percent; strong acceptance has a probability of 60 percent. The payoffs are as follows. Small job shop, moderate market = $24,000; Small job shop, strong market = $54,000. Medium job shop, moderate market = $20,000; medium job shop, strong market = $64,000. Large job shop, moderate market = -$2,000; large job shop, strong market = $96,000. Which capacity choice should the firm make? Answer: The expected values for the three decision alternatives (capacities) are: small job shop = $42,000; medium job shop = $46,400; and large job shop = $56,800. The firm should choose the large job shop. Diff: 2 AACSB: Analytic skills Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes 5) A firm is about to undertake the manufacture of a product, and it is weighing three capacity alternatives: small job shop, large job shop, and repetitive manufacturing. The small job shop has fixed costs of $3,000 per month, and variable costs of $10 per unit. The larger job shop has fixed costs of $12,000 per month and variable costs of $3 per unit. The repetitive manufacturing plant has fixed costs of $30,000 and variable costs of $1 per unit. Demand for the product is expected to be 1,000 units per month with "moderate" market acceptance, but 2,000 under "strong" market acceptance. The probability of moderate acceptance is estimated to be 60 percent; strong acceptance has a probability of 40 percent. The product will sell for $25 per unit regardless of the capacity decision. Which capacity choice should the firm make? Answer: The payoffs are as follows: small job shop, moderate acceptance = $12,000; small job shop, strong acceptance = $27,000; large job shop, moderate acceptance = $10,000; large job shop, strong acceptance = $32,000; repetitive manufacturing, moderate acceptance = -$6,000; and repetitive manufacturing, strong acceptance = $18,000. The expected value for the small job shop decision alternative is $18,000. The expected value of the large job shop alternative is $18,800. The expected value for the repetitive manufacturing alternative is $3600. The firm should choose the large job shop capacity alternative. Diff: 3 AACSB: Analytic skills Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes 6) Suppose that the market has a 70% chance of being favorable and a 30% chance of being unfavorable. A favorable market will yield a profit of $300,000, while an unfavorable market will yield a profit of $20,000. What is the expected monetary value (EMV) in this situation? Answer: EMV = (0.7)($300,000) + (0.3)($20,000) = $210,000 + $6,000 = $216,000 Diff: 2 AACSB: Analytic skills Objective: LO5 Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes S7-25