Question

The Lake Placid Town Council decided to build a new community center to be used for conventions, concerts, and other public events, but considerable controversy surrounds the appropriate size. Many influential citizens want a large center that would be a showcase for the area. But the mayor feels that if demand does not support such a center, the community will lose a large amount of money. To provide structure for the decision process, the council narrowed the building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical factor in choosing the best size is the number of people who will want to use the new facility. A regional planning consultant provided demand estimates under three scenarios: worst-case, base-case, and best-case. The worst-case scenario corresponds to a situation in which tourism drops substantially; the base-case scenario corresponds to a situation in which Lake Placid continues to attract visitors at current levels; and the best-case scenario corresponds to a substantial increase in tourism. The consultant has provided probability assessments of 0.10, 0.60, and 0.30 for the worst-case, base-case, and best-case scenarios, respectively. The town council suggested using net cash flow over a 5-year planning horizon as the criterion for deciding on the best size. The following projections of net cash flow (in thousands of dollars) for a 5-year planning horizon have been developed. All costs, including the consultant’s fee, have been included. Demand Scenario Center Size Worst-Case Base-Case Best-Case Small 380 590 810 Medium -160 650 870 Large -400 560 1090 What decision should Lake Placid make using the expected value approach? Small or Medium Identify the risk profiles for the alternatives. (i) (ii) (iii) Risk profile for small-size community center: Graph (iii) Risk profile for medium-size community center: Graph (i) Given the mayor's concern over the possibility of losing money and the result of part (a), which alternative would you recommend? Small or Large Compute the expected value of perfect information. Enter your answer in thousands of dollars. EVPI = $ thousands. Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur? Best decision: Yes Suppose the probability of the worst-case scenario increases to 0.2, the probability of the base-case scenario decreases to 0.5, and the probability of the best-case scenario remains at 0.3. What effect, if any, would these changes have on the decision recommendation? It will not have an effect change to large The consultant has suggested that an expenditure of $130,000 on a promotional campaign over the planning horizon will effectively reduce the probability of the worst-case scenario to zero. If the campaign can be expected to also increase the probability of the best-case scenario to 0.4, is it a good investment? Enter your answers in thousands of dollars. If the promotional campaign is conducted, a large center size would be selected. This would give an expected value of $ thousands. This is a $ thousands increase over the answer in part (a).

Answer 1