Question

ABC Ride (ABC university bike share system) penalizes customers who rent a bike for many hours by charging them very high price. Why does ABC set such a price scheme?

A Because ABC wants to maximize the profit.

B Because ABC knows that the repair cost of the bike is expensive.

C Because ABC wants to make sure bikes are available to many students.

D Because ABC wants to reduce the maintenance cost of the Wolf Ride bike system.

E Because ABC wants students to purchase their own bikes.

A logistics provider plans to have a new warehouse built to handle increasing demands for its services. Although the company is unsure of how much demand there will be, it must decide now on the size (large or small) of the warehouse. Preliminary estimates are that if a small warehouse is built and demand is low, the monthly income will be $400. If demand is high, it will have to either expand the facility or lease additional space. Leasing will result in a monthly income of $300 while expanding will result in a monthly income of $700. If a large warehouse is built and demand is low, monthly income will only be $200, while if demand is high, monthly income will be $1000. Assume that the probability that the demand is high is 50% and the probability that the demand is low is 50%. Find EVPI (expected value of the perfect information).

A 100

B 150

C 200

D 250

E 300

Answer 1

a. Because ABC wants to make sure bikes are available to many students.

Penalties are imposed by organization to deter the customers or users from acting in a particular way. Penalties are never imposed to increase profit. Hence option A is wrong. Also penalty amount is not determined by analyzing the costs incurred. Hence option B and D are wrong. Option E is wrong as if student purchase their own bikes the business of ABC will in turn be impacted. Option C is correct as with high penalties students will be try to use the bikes for only the required duration and return them when not required. Thus the bikes will be available when the other students require the bikes.

b. A 100

To calculate the EVPI we need to first calculate EMV and EM|PI. EMV is the Expected Market Value and EM|PI is the Expected Value if Perfect Information is available

The decision tree for the given problem is given above.

Expected Value of building a large warehouse = 0.5*200+0.5*1000= 100+500 = $600

We can see that if small warehouse is built and demand is high, the provider will expand the facility as it has more income than leasing. Hence expected value of building a small warehouse is as below

Expected value of building a small warehouse = 0.5*400 + 0.5*MAX(300,700) = 200+0.5*700 = 200+350 = $550

This EMV = MAX (Small warehouse, Large Warehouse) = MAX (550,600) = $600

Now EV|PI is the expected value if perfect information was available. If the provide knew that the demand would be low, he would build a small warehouse while if the provider knew beforehand the demand would be high he would build a large warehouse. Hence EV|PI is as below

EV|PI = Probability of low demand* Income from small warehouse + Probability of high demand*Income from large warehouse

EV|PI = 0.5*400+0.5*1000 = 200+500 = $700

Hence EVPI = EV|PI - EMV = $700- $600 = $100