Pavlo Paxton is the owner of Paxton’s Landscaping located in Plano,Texas. Pavlo is trying to decide how to expand his business. Pavlo’s alternatives are to expand his existing facility or build a second facility at another location.
If he decides to expand his existing facility and the demand grows significantly, the result would be a net profit of $20,000. If demand growth is moderate, result would be a net profit of $10,000 and if demand slows, result would be a net loss of $12,000.
If he builds a new facility, the results would be a net profit of $30,000 if demand grows significantly, net profit of $14,000 if demand growth is moderate and a net loss of $20,000 if demand slows.
Without any further information, Pavlo estimates the probabilities of demand as: significant growth 0.20, moderate growth 0.50 and slow 0.30.
BEFORE making the facility decision, Pavlo could hire an independent market research firm to do a survey. The survey will indicate either positive or negative market conditions. Past experience indicates there is a 57% chance of a positive result, 43% chance of a negative result. Pavlo could then use the survey results to decide whether to expand or build new.
If the survey result is positive, the probability of significant growth is estimated to be 0.50, moderate growth 0.40 and slowing 0.10. If the survey result is negative, the probability of significant growth is estimated to be 0.15, moderate growth 0.40 and slowing 0.45.
The survey would cost $$1,000 so the payoffs must be adjusted to reflect that cost if the research firm is hired.
a. Draw and solve a decision tree for this problem
b. Write your recommendation.