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: DemandStaffing Options High Medium LowOwn staff 650 650 600Outside vendor 900 600 300Combination 800 650 500 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?

Question

Business

Arjun Moses

1 September, 12:04

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: DemandStaffing Options High Medium LowOwn staff 650 650 600Outside vendor 900 600 300Combination 800 650 500 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?

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Maddison Lynch · Answer 1

Judging from the payoff table below, the option that gives the lowest cost is outsourcing data processing to external vendor as this lead to total costs $570000 as against other two options that would incur $635000 respectively.

By choosing outsourcing, Hudson Corporation is saving $65000 ($635000-$570000).

Explanation:

The expected cost in each of the alternative is calculated by multiplying together the probability of state of nature with the corresponding payoff value.

Hence, the below is the payoff table:

Expected Value (own staff) = 650 (0.2) + 650 (0.5) + 600 (0.3) = $635

Expected value (Outsourcing) = 900 (0.2) + 600 (0.5) + 300 (0.3) = $570

Expected value (combined) = 800 (0.2) + 650 (0.5) + 500 (0.3) = $635