What is the importance of having a probability analysis?

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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:

FacilityDemand OptionsProbabilityActionsExpected Payoffs
LargeLow Demand0.4Do Nothing($10)
Low Demand0.4Reduce Prices$50
High Demand0.6$70
SmallLow Demand0.4$40
High Demand0.6Do Nothing$40
High Demand0.6Overtime$50
High Demand0.6Expand$55

Decision Tree

Determination of chance probability and respective payoffs:

Build Small:
Low Demand0.4($40)=$16
High Demand0.6($55)=$33
Build Large:
Low Demand0.4($50)=$20
High Demand0.6($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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