A plant manager wants to know how much he should be willing to pay for perfect market research. Currently there are two states of nature facing his decision to expand or do nothing. Under favorable market conditions the manager would make $100,000 for the large plant and $5,000 for the small plant. Under unfavorable market conditions the large plant would lose $80,000 and the small plant would make $0. If the two states of nature are equally likely, how much should he pay for perfect information?

A. 55,000b. $25,000c. Unable to determine with this informationd. $15,000e. $0

Option (B) is correct.

Explanation:

Probability:

Favorable Market condition (P1) = 0.5

Unfavorable Market Condition (P2) = 0.5

Small plant:

Favorable Market condition = $5,000

Unfavorable Market Condition = $0

Therefore,

Total Expected to make from small plant:

= P1 * $5,000 + P2 * $0

= 0.5 * $5,000 + 0.5 * $0

= $2,500

Large plant:

Favorable Market condition = $100,000

Unfavorable Market Condition = (-$50,000)

Therefore,

Total Expected to make from small plant:

= P1 * $100,000 + P2 * (-$50,000)

= 0.5 * $100,000 + 0.5 * (-$50,000)

= $50,000 - $25,000

= $25,000

From the above calculation, if he goes for a small plant he can make $2,500 and if he goes for a large plant he can make $25,000 so maximum he can make is $25000 so he can maximum pay $25000 only for research.