Confronting Action DecisionsConfronting Action Decisions

Decision Problem:Phoenix or Denver? - Where to site the plant?

PV of Gross Profit Streams (Dollars millions)

Scenario Probability Phoenix Denver

Best Case .20 25 20

Most Likely .60 20 17

Worst Case .20 9 9

PV of Plant Cost (25yrs) 15 12

Confronting Action DecisionsConfronting Action Decisions

Decision Problem:Phoenix or Denver? - Where to site the plant?

DecisionNode

Do Not Expand

0

Phoenix

EventNode

.2 Best

.6 Likely

.2 Worst

10

5

-6

PV of NetProfit*

*Gross profit minus Plant Cost

ExpectedPay-off

.2(10)+ .6(5)+ .2(-6)

$3.8mm

Denver

.2 Best

.6 Likely

.2 Worst

8

5

-3

.2(8)+ .6(5)+ .2(-3)

$4.0mm

Confronting Action DecisionsConfronting Action Decisions

Decision Problem:Outcome sensitive to probability distribution?

DecisionNode

Do Not Expand

0

PV of NetProfit*

*Gross profit minus Plant Cost

Phoenix

Event Node

.35 Best

.50 Likely

.15 Worst

10

5

-6

Denver

.35Best

.50 Likely

.15 Worst

8

5

-3

ExpectedPay-off

.35(10)+ .5(5)+ .15(-6)

$5.1mm

.35(8)+ .5(5)+ .15(-3)

$4.85mm

Confronting Action DecisionsConfronting Action Decisions

Decision Problem:Probability distributions differ by location?

DecisionNode

Do Not Expand

0

PV - NetProfit*

*Gross profit minus Plant Cost

Phoenix

EventNode

.35 Best

.50 Likely

.15 Worst

10

5

-6

Denver

.45Best

.50 Likely

.05 Worst

8

5

-3

ExpectedPay-off

.35(10)+ .5(5)+ .15(-6)

$5.1mm

.45(8)+ .5(5)+ .05(-3)

$5.95mm

Hong Pou$ry Entry CaseHong Pou$ry Entry Case

Enter

No Enter

$0

Price =

$.85/lb

Price =$.49/lb

p =.5

(1-p) =.5 Stay

Exit

-$17,000

-$10,000

Net Profit

E(Lo) = .5(-10,000) = -$5,000

ExpectedNet Profit

Stay

Exit

$54,200

$8,000

E(Hi) = .5(54,200) = $27,100

Expected Consequence ofEntry = $22,100 = E(Hi) + E(Lo)

Hong Poultry Entry CaseHong Poultry Entry Case

Hong Poultry Entry CaseHong Poultry Entry CaseCritical Decision Values

PROBABILITY How low can success probability go?

Expected Value of Entry = Expected Value of Exit

P*[54,000] = (1-P*)[-10,000] ==> P* = .226

P - P* - Margin of error

EXIT COST -- A possible barrier to entry?

P*[54,000] = (1-P*)[-15,000] ==> P* = .383

Expected Monetary Value Decision-Making

Expected Monetary Value Decision-Making

Competition?

YES

NO

Market

Don’t M

arket

High

Medium

Low

(.4)

(.5)

(.1)

CompetitorPrice

High

Medium

Low

(.15)

(.5)

(.35)

High

Medium

Low

(.1)

(.2)

(.7)

(.8)

(.2)

3.5

Firm’sPrice

High

Medium

Low

Payoff($000)

$15

-$5

-$20

$30

$10

-$20

$65.0

$15

$5

-$5

$1.5

$2.5

-$1.0

$2.5

$15