Risk and uncertainty – constructing the pay-off table

The principles are,the same as F5, it is just a different example.

John has a factory capacity of 1,200 units per month. Units cost him $6 each to make and his normal selling price is $11 each. However, the demand per month is uncertain and is as follows: Demand 400 500 700 900 Probability 0.2 0.1 He has been approached by a customer who is prepared to contract to a fixed quantity per month at a price of $9 per unit. The customer is prepared to sign a contract to purchase 300, 500, 700 or 800 units per month. 0.3 0.4 The company can vary production levels during the month up to the maximum capacity, but cannot carry forward any unsold units in stock.

So, if John signs a contract with the special,customer to supply 500 per month, these take priority.

If the demand from regular customers is 900 units, because only 1200 can be made in total, 500 will go to the special customer making 9-6 but only 700 can go to regular customers making 11-6. Total profit is 500 x 3 + 700 x 5 = 5000.

Similarly for other combinations.