<Problem 4-15The 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 centethat 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 buildingalternatives 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 demandestimates 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 Placidcontinues 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, andbest-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 beendeveloped. All costs, including the consultant's fee, have been included.Center Size Worst-Case Base-Case Best-CaseSmall400500660Medium-250650Large-400580Medium or Largea. What decision should Lake Placid make using the expected value approach?(1)Probabilityb. Identify the risk profiles for the medium and large alternatives.0.6Demand Scenario0.40.20.6800990-4000 400Net Cash Flow800Previous Next > (ii)(iii)ProbabilityProbabilitySmall0.60.40.20.60.40.2-400-400EVPI $ 122,0000Net Cash Flow400 800Risk profile for medium-size community center:Risk profile for large-size community center:Given the mayor's concern over the possibility of losing money and the result of part (a), which alternative would you recommend?0 400 800Net Cash Flowc. Compute the expected value of perfect information.Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur?PreviousNext

Worst caseBase caseBest caseSmall400500660Medium-250650800Large-400580990Probability0.100.600.30

Answered: a. What decision should Lake Placid…

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Problem 4-15
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 cente
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.
Center Size Worst-Case Base-Case Best-Case
Small
400
500
660
Medium
-250
650
Large
-400
580
Medium or Large
a. What decision should Lake Placid make using the expected value approach?
(1)
Probability
b. Identify the risk profiles for the medium and large alternatives.
0.6
Demand Scenario
0.4
0.2
0.6
800
990
-400
0 400
Net Cash Flow
800
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Transcribed Image Text:(ii) (iii) Probability Probability Small 0.6 0.4 0.2 0.6 0.4 0.2 -400 -400 EVPI $ 122,000 0 Net Cash Flow 400 800 Risk profile for medium-size community center: Risk profile for large-size community center: Given the mayor's concern over the possibility of losing money and the result of part (a), which alternative would you recommend? 0 400 800 Net Cash Flow c. Compute the expected value of perfect information. Do you think it would be worth trying to obtain additional information concerning which scenario is likely to occur? Previous Next

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