01 Jun Question 3-17 Kenneth Brown is the principal owner of Brown Oil, Inc. After quittin
Question
3-17
Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:
FAVORABLE UNFAVORABLE
MARKET MARKET
EQUIPMENT ($) ($)___
Sub 100 300,000 – 200,000
Oiler J 250,000 – 100,000
Texan 75,000 – 18,000
For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000.
But Ken has always been a very optimistic decision maker.
(a) What type of decision is Ken facing?
(b) What decision criterion should he use?
(c) What alternative is best?
Problem 3-19
The Lubricant is an expensive oil newsletter to which many oil giants subscribe, including Ken Brown (see Problem 3-17 for details). In the last issue, the letter described how the demand for oil products would be extremely high. Apparently, the American consumer will continue to use oil products even if the price of these products doubles. Indeed, one of the articles in the Lubricant states that the chances of a favorable market for oil products was 70%, while the chance of an unfavorable market was only 30%. Ken would like to use these probabilities in determining the best decision.
a.) What decision model should be used?
b.) What is the optimal decision?
c.) Ken believes that the $300,000 figure for the Sub 100 with a favorable market is too high. How much lower would this figure have to be for Ken to change his decision made in part (b)?
EQUIPMENT FAVORITE MARKET UNFAVORABLE MARKET
Sub 100 300,000 -200,000
Oiler J 250,000 -100,000
Texan 75,000 -18,000
Problem 3-22
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