The owner of Tastee Cookies needs to decide whether to lease a small, medium, or large new retail outlet. She estimates that monthly profits will vary with demand for her cookies as follows: $\begin{array}{|l|l|l|l|}
\hline\text {SIZE}\
\text {OF}&\text {DEMAND}\
\hline \text { OUTLET } & \text { LOW } && \text { HIGH } \
\hline \text { Small } & \$ 1,000 && 1,000 \
\hline \text { Medium } & 500 && 2,500 \
\hline \text { Large } & 0 && 3,000 \
\hline
\end{array}$ If she feels there is a 30 percent chance that demand will be high, what is her expected value of perfect information?
A) $1,600
B) $1,100
C) $1,000
D) $900
E) $500

Question

Quizplus · Accepted Answer

The expected value of perfect information (EVPI) is calculated by finding the difference between the expected profit with perfect information and the expected profit without perfect information. With perfect information, she would choose the large outlet if demand is high and the small outlet if demand is low. The expected profit with perfect information is $0.3 \times 3000 + 0.7 \times 1000 = 1600$. Without perfect information, she would choose the medium outlet, giving an expected profit of $0.3 \times 2500 + 0.7 \times 500 = 1100$. The EVPI is $1600 - 1100 = 500$.

The Owner of Tastee Cookies Needs to Decide Whether to Lease