What is the importance of having a probability analysis?

Probability Analysis

A General Manger of Harley-Davidson has to decide on the size of a new facility. The GM has narrowed the choices to two: large facility or small facility. The company has collected information on the payoffs. It now has to decide which option is the best using probability analysis, the decision tree model, and expected monetary value.

Options:

Facility Demand Options Probability Actions Expected Payoffs
Large Low Demand 0.4 Do Nothing ($10)
Low Demand 0.4 Reduce Prices $50
High Demand 0.6 $70
Small Low Demand 0.4 $40
High Demand 0.6 Do Nothing $40
High Demand 0.6 Overtime $50
High Demand 0.6 Expand $55

Decision Tree

Determination of chance probability and respective payoffs:

Build Small:
Low Demand 0.4($40)=$16
High Demand 0.6($55)=$33
Build Large:
Low Demand 0.4($50)=$20
High Demand 0.6($70)=$42

Determination of Expected Value of each alternative
Build Small: $16+$33=$49
Build Large: $20+$42=$62

The Statistical Terms review sheet is attached below.

 

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