The national coffee store Farbucks needs to decide in June how many holiday-edition insulated coffee mugs to order. Because the mugs are dated, those that are unsold by January 15 are considered a loss (these mugs are then discounted and sold for $5.00 each after January 15). These premium mugs sell for $23.95 and cost $6.75 each. Farbucks is uncertain of the demand. They believe that there is a 25% chance that they will sell 10,000 mugs, a 50% chance that they will sell 15,000, and a 25% chance that they will sell 20,000. Should they order 12,000, 15,000, or 18,000 mugs? a) Use a decision tree approach to help them make the decision.
b) Create cumulative risk profiles for all three strategies. Is one strategy stochastically dominant? Explain.
c) Calculate the EVPI for this decision.