Part 1 Of 3: Kenneth Brown Is The Principal Owner Of Br ✓ Solved

Part 1 Of 3 Part 1kenneth Brown Is The Principal Owner Of Brown Oil

Part 1 of 3 - Part 1 Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is considering purchasing some additional equipment for Brown Oil due to increased competition. His options are shown in the following table: Equipment with favorable market and probabilities, along with potential profits or losses in favorable and unfavorable markets. For example, purchasing a Sub 100 results in a profit of $300,000 if the market is favorable, and a loss of $200,000 if unfavorable. The likelihood of favorable market conditions is 70%, while unfavorable is 30%. Ken is an optimistic decision maker, but his brother Bob, vice president of finance, attributes the company's success to his pessimistic attitude. Bob wants to decide based on the Maximin criterion, which chooses the option with the best possible worst-case scenario. He is evaluating which equipment to choose under these conditions, calculating expected monetary values, and considering the potential maximum profit assumptions.

Questions include determining which equipment Bob would choose using the Maximin criterion, calculating the EMV for each piece of equipment, deciding which option maximizes EMV, and understanding the required minimum profit assumption for the Sub 100 equipment if Ken believes it cannot reach $300,000 even in favorable conditions.

Sample Paper For Above instruction

In the highly competitive oil industry, strategic decision-making can significantly influence a company's profitability and sustainability. Kenneth Brown, as the principal owner of Brown Oil, faces critical choices concerning equipment investments to maintain competitive advantage. The dilemma involves selecting equipment from options such as Sub 100, Oiler J, and Texan, each with different profit or loss profiles contingent upon market conditions. This paper analyzes the decision-making process under risk and uncertainty, applying various decision criteria including Maximin and Expected Monetary Value (EMV), and evaluates the financial implications of each choice.

The Maximin criterion emphasizes pessimistic decision-making, selecting the option with the best worst-case scenario. For each equipment choice, the minimum payoff under unfavorable conditions is considered. The Sub 100 equipment, with a loss of $200,000 in the worst case, stands as Ken's risk-averse choice. Oiler J, with a worst-case loss of $100,000, and Texan, with a worst-case loss of $18,000, exhibit less severe downside risks. Based on the Maximin approach, the equipment with the highest minimum payoff—in this case, Texan with a loss of $18,000—is preferred. Hence, the optimal choice for a pessimistic decision-maker like Bob would be Texan.

Calculating the Expected Monetary Value provides a more balanced approach by considering the probability-weighted average of outcomes. The EMV of each equipment option is computed as follows:

For Sub 100: EMV = (Probability of favorable market × favorable outcome) + (Probability of unfavorable market × unfavorable outcome). Sub 100 yields a profit of $300,000 in the favorable market with a 70% chance, and a loss of $200,000 with a 30% chance: EMV = 0.7 × 300,000 + 0.3 × (-200,000) = $210,000 - $60,000 = $150,000.

The EMV for Oiler J, which has a favorable outcome of $250,000 and an unfavorable outcome of -$100,000, is computed as: EMV = 0.7 × 250,000 + 0.3 × (-100,000) = $175,000 - $30,000 = $145,000.

For Texan, with favorable and unfavorable outcomes of $75,000 and -$18,000 respectively, EMV = 0.7 × 75,000 + 0.3 × (-18,000) = $52,500 - $5,400 = $47,100.

Thus, the equipment choice that maximizes the EMV in Ken’s optimistic approach is Sub 100, with an EMV of $150,000, closely followed by Oiler J. This quantitative analysis guides Ken towards investments that optimize expected returns under risk.

Furthermore, if Ken believes that the Sub 100 equipment cannot achieve $300,000 profit even under favorable market conditions, then this expected figure becomes unreliable. In such cases, the minimum acceptable profit estimate for Sub 100 should be adjusted based on revised market expectations. For instance, if the maximum realistic profit is $200,000, then the potential profit figure needs to be at least that amount, influencing the decision-making process.

In conclusion, the choice of equipment for Brown Oil depends on the decision criterion employed. The Maximin approach prioritizes safety and risk aversion, favoring Texan, while the EMV approach aims for maximizing average expected returns, favoring Sub 100 or Oiler J. An understanding of market probabilities and outcome estimates is essential to making informed investment decisions in a volatile industry.

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