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

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