Meega airlines decided to offer direct service from Akron to Clearwater Beach, Florida. Management must decide between full-price service using a company's new fleet of jet aircraft and a discount-service using smaller capacity commuter planes. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service on Clearwater Beach: high, moderate, and low. The following table shows the estimated quarterly profits (in thousands of dollars):
?
Demand for service
ServiceHighMediumLowFull Price900760-430Discount710650350?
a. If the demand probabilities are 0.3, 0.5, and 0.2, what is the best decision using the expected value approach?
b. Construct a risk profile for the optimal decision in part a. What is the probability of the profit exceeding $700,000?
?
What will be an ideal response?
a. EV(Full) = 0.3(900) + 0.5(760) + 0.2(-430) = 564 or $564,000
EV(Discount) = 0.3(710) + 0.5(650) + 0.2(350) = 608 or $608,000
Optimal Decision: Discount service
b. The risk profile is shown in tabular form. The probability that the cost exceeds $700,000 is 0.3.
Profit | Probability |
$350 | 0.2 |
$650 | 0.5 |
$710 | 0.3 |
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