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A firm must decide whether to construct a small, medium, or large stamping plant. A consultant’s

report indicates a .20 probability that demand will be low and an .80 probability that demand will

be high.

If the firm builds a small facility and demand turns out to be low, the net present value will

be \$42 million. If demand turns out to be high, the firm can either subcontract and realize the net

present value of \$42 million or expand greatly for a net present value of \$48 million.

The firm could build a medium-size facility as a hedge: If demand turns out to be low, its net

present value is estimated at \$22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of \$46 million, or it could expand and realize a net present

value of \$50 million.

If the firm builds a large facility and demand is low, the net present value will be –\$20 million,

whereas high demand will result in a net present value of \$72 million.

a. Analyze this problem using a decision tree.

b. What is the maximin alternative?

c. Compute the EVPI and interpret it.

d. Perform sensitivity analysis on P(high)