C and S Metal company produces stainless steel pots and pans. C and S can pursue either of two distribution plans for the coming year. The firm can either produce pots and pans for sale under a discount store label or manufacture a higher quality line for speciality stores and expensive mail order catalogues. High initial set-up costs along with C and S's limited capacity make it impossible for the firm to produce both lines. Profits under each plan depend upon the state of the economy. One of the three conditions will prevail:
Growth (probability = 0.3)
Normal (probability = 0.5)
Recession (probability = 0.2)
The outcome under each plan for each state of the economy is given in the table below. Figures in the table are profits measured in dollars. The probabilities for each economic condition represent crude estimates.
|
Economic condition
|
Discount line
|
Speciality line
|
|
Growth
Normal
Recession
|
250,000
220,000
140,000
|
400,000
230,000
20,000
|
(a) Calculate the expected value for each alternative.
(b) Which alternative is more risky?
(c) Taking into account the importance of risk, which alternative should an investor choose?