Question

A manager must decide how many machines of a certain type to buy. The machines will be used to manufacture a new gear for which there is increased demand. The manager has narrowed the decision of two alternatives: buy one machine or buy two. If only one machine is purchased and demand is more than it can handle, a second machine can be purchased at a later time. However, the cost per machine would be lower if the two machines were purchased at the same time.



The estimated probability

of low demand is 0.30 and the estimated probability of high demand is 0.70.



The net present value

associated with the purchase of two machines initially is $75000 if demand is

low and $130000 if demand is high.



The net present value for

one machine and low demand is $90000. If demand is high, there are three

options. One option is to do nothing, which would have a net present value of

$90000. A second option is to subcontract; that would have a net present value

of $110000. The third option is to purchase a second machine. This option would

have a net present value of $100000.



How many machines should

the manager purchase initially? Use a decision tree to analyse this problem.

Answer 1

Answer:

manager should purchase both the machines initially.

Explanation:

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