If he feels the chances of low, normal, and high precipitation are 30 percent, 20 percent, and 50 percent respectively, What is EVPI (Expected value of Perfect Information) ?

Question:

The operations manager for a well-drilling company must recommend whether to build a new facility, expand his existing one, or do nothing. He estimates that long-run profits (in $000) will vary with the amount of precipitation (rainfall) as follows:

Alternative Precipitation

Low Normal High

Do nothing - 100 100 300

Expand 350 500 200

Build new 750 300 0

If he feels the chances of low, normal, and high precipitation are 30 percent, 20 percent, and 50 percent respectively, What is EVPI (Expected value of Perfect Information) ?

A. $140,000

B. $170,000

C. $285,000

D. $305,000

E. $475,000

Answer:

D. $170,000

Explanation:

The expected long run profits are for

Low Normal High

Do nothing - 100*0.3 100*0.2 300*0.5 = 140

Expand 350*0.3 500*0.2 200*0.5 = 305

Build new 750*0.3 300*0.2 0*0.5 = 285

Therefore the expected long run profits are

$140,000

$305,000

$285,000

Based on his selected option being either to build new or to expand, the most profitable option is to expand

=$305,000

EVPI = EPPI-EMV = $170,000