Hudson Corporation is considering three options for managing its data processing operation: continuing with its own staff, hiring an outside vendor to do the managing (referred to as outsourcing), or using a combination of its own staff and an outside vendor. The cost of the operation depends on future demand. The annual cost of each option (in thousands of dollars) depends on demand as follows: Demand
Staffing Options High Medium Low
Own staff 650 650 600
Outside vendor 900 600 300
Combination 800 650 500
a) If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data processing operation?
Own staff, Outside vendor, Combination
What is the expected annual cost associated with that recommendation?
Expected annual cost = $
(b) Construct a risk profile for the optimal decision in part (a).
What is the probability of the cost exceeding $700,000?
Probability =

Kindly check explanation

Explanation:

Given the data :

DEMAND

Staffing option __High ___MediumLow

Own staff 650 650 600

Outside vendor _900 600 300

Combination ___ 800 650 500

a) If the demand probabilities are 0.2, 0.5, and 0.3, which decision alternative will minimize the expected cost of the data processing operation?

Expected cost :Σp(x) *x

Expected value for OWN STAFF:

(650*0.2) + (650*0.5) + (600*0.3) = 635

Expected value for OUTSIDE VENDOR:

(900*0.2) + (600*0.5) + (300*0.3) = 570

Expected value for COMBINATION:

(800*0.2) + (650*0.5) + (500*0.3) = 635

The decision alternative which will minimize expected cost is OUTSIDE VENDOR as it has the lowest expected value.

Expected annual cost associated with outside vendor is 570

(b) Construct a risk profile for the optimal decision in part (a).

Risk portfolio for outside vendor:

Demand cost probability

Low 900 0.2

Medium 600 0.5

High 500 0.3

What is the probability of the cost exceeding $700,000?

Probability : This is the probability associated with the low demand of the optimal risk portfolio = 0.2 (0.2 * 100) = 20%