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1. A fast food restaurant chain is considering a store expansion program. The most important factor to consider is next two year’s level of interest rate. It is estimated that there is a 30% chance that it goes up, a 50% chance that it stays same, and a 20% chance that it goes down. The strategies and corresponding expected payoffs (profit) are: Rate goes-up Rate stays same Rate goes-down (30%) (50%) (20%) Build 10 new places $300,000 $50,000 $250,000 Build 5 new places $150,000 $26,000 $80,000 Do nothing $70,000 0 $25,000 Draw a decision tree. Calculate expected value at every node. What should they do?
Expert Answer
For A, Expected Profit = .3*300000 + .5*50000 + .2*250000 = $165000
For B, Expected profit = .3*150000 + .5*26000 + .2*80000 = $74000
For C, Expected profit = .3*70000 + .5*0 + .2*25000 = $26000
Since building 10 places will give maximum profit, hence the fast food restaurant should chose this alternative.
