Understanding Risk tolerance levels, business and finance homework help

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zpynera11

Business Finance

Description

BUYU Manufacturing has been contracted to provide SAEL Electronics with printed circuit and motherboards (PC) boards under the following terms:

100,000 PC boards will be delivered to SAEL in one month.

In 3 months, SAEL has an option to take the delivery of an additional 100,000 boards by giving BUYU a 30-day notice.

SAEL will pay $5 for each board it takes.

BUYU manufactures the PC boards through a process called batching, and manufacturing costs are as follows:

The manufacturing batch run has a fixed setup cost of $250,000, regardless of the run size.

The marginal manufacturing cost is $2.00 per board, regardless of the size of the batch run.

BUYU must decide whether it should manufacture all 200,000 PC boards now, or if it should manufacture 100,000 now and the other 100,000 boards only if SAEL decides to buy them. If BUYU manufactures 200,000 now and SAEL does not exercise its option, then BUYU will lose the manufacturing cost of the extra 100,000 boards. BUYU believes that there is a 50% chance that SAEL will exercise its option to buy the additional 100,000 PC boards.

1. Discuss the potential profit of manufacturing all 200,000 boards now.

2. Draw a decision tree for the decision that BUYU faces.

3. If BUYU uses its expected profit as the basis for its decision, determine the preferred course of action.

4. Determine the range of values of the probability that SAEL will exercise its option, making the decision found in part c as optimal, and determine the expected value of perfect information about whether SAEL will exercise its option.

5. Assume now that BUYU is constantly risk averse with a risk tolerance of $100,000, and answer parts 3 and 4 again.

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Explanation & Answer

with case citation

Question No # 1
In the scenario, the BUYU is manufacturing 100,000 PC boards that will be offered for
sale to SAEL electronics at a rate of $5 per board. The estimated cost of manufacturing per board
is $2 and the fixed cost of manufacturing remains same which is $250,000 (Kirkwood, 1996).
The three months after the plan, the SAEL Company is considering the option of purchasing
100,000 boards in the time duration of a month.

Potential Profit if 200,000 boards are manufactured now:
Revenue (200,000*$5)
$1,000,000
Less: Variable Manufacturing Cost (200,000*$2)
$400,000
Less: Fixed Manufacturing Cost
$250,000
Profit
$350,000
Question No # 2
The decision tree of the BUYU is developed as the company has different options of
manufacturing board units. They are able to produce 200,000 boards now or 100,000 boards...


Anonymous
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