Steve Gentry, the operations manager of Baja Fabricators, wants to purchase a new profiling machine (it cuts compound angles on the ends of large structural pipes used in the fabrication yard)
However, because the price of crude oil is depressed, the market for such equipment is down. Steve believes that the market will improve in the near future and that the company should expand its capacity. The table below displays the three equipment options he is currently considering, and the profit he expects each one to yield over a two-year period. The consensus forecast at Baja is that there is about a 30% probability that the market will pick up "soon" (within 3 to 6 months) and a 70% probability that the improvement will come "later" (in 9 to 12 months, perhaps longer).
Profit from Capacity Investment (in Dollars)
Equipment Option Market picks up "soon"
p = 0.30 Market picks up "later"
p = 0.70
Manual Machine -120,000 210,000
NC Machine 140,000 160,000
CNC Machine 200,000 -200,000
a. Calculate the expected monetary value of each decision alternative.
b. Which equipment option should Steve take?
(a) The expected monetary values are: "Manual machine" $111,000, "NC Machine" $154,000, and "CNC Machine" -$80,000.
(b) Based upon the EMV criterion, Baja should purchase an NC machine.
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