Question

(Bonus)

Joseph is considering expanding the basketball section of his store. He can build a large section, a small section, gather additional information, or do nothing. If he gathers additional information, the results could suggest either a favorable or an unfavorable market, but it would cost him $3,000 to gather the information. Joseph believes that there is a 50–50 chance that the information will be favorable. If the market is favorable, he will earn $15,000 with a large section or $5,000 with a small one. With an unfavorable market, however, Joseph could lose $20,000 with a large section or $10,000 with a small section. Without gathering additional information, he estimates that the probability of a favorable market is 0.7. A favorable report from the study would increase the probability of a favorable market to 0.9. Furthermore, an unfavorable report from the additional information would decrease the probability of a favorable market to 0.4. Of course, Joseph could ignore these numbers and do nothing.

What should Joseph do?

Select one:

a. Gather more information. If the report is favorable, build large. If it is unfavorable, do nothing.

b. Gather more information. If the report is favorable, build large. If it is unfavorable, build small.

c. Build small without gathering information first.

d. Get an unfavorable report

e. Build large without gathering information first.

f. Gather more information. If the report is favorable, build small. If it is unfavorable, do nothing.

g. Build large and get a favorable market.

h. Build small and get a favorable market.

i. Get a favorable report

Answer 1

In my opinion, Joseph must do the below:

He must gather more information. If the report is favorable, build large. If it is unfavorable, do nothing.

This is because if the report is favorable, then the earning in case of large section is $15000 whereas in case of small section is $5000. Also the the probability of favorable market increases to 0.9 in case of favorable market report. Hence there is a very high chance of earning a revenue of $15000 for Joseph in case of favorable market report if he builds large section. In case report is unfavorable, then e must do nothing since there is 0.6 probability of unfavorable market conditions if the report is unfavorable. Also the cost of report is similar in both large or small section, i.e. $3000. Hence it makes more sense to go for building large section to due high probability of larger earnings.