Gym Bunnies (GB) is a health club. It currently has 6000 members, with each member paying a subscription fee of $720 per annum. The club is comprised of a gym, a swimming pool and a small exercise studio. A competitor company is opening a new gym in GB’s local area, and this is expected to cause a fall in GB’s membership numbers, unless GB can improve its own facilities. Consequently, GB is considering whether or not to expand its exercise studio in a hope to improve its membership numbers. Any improvements are expected to last for three years. Option 1 No expansion. In this case, membership numbers would be expected to fall to 5250 per annum for the next three years. Operational costs would stay at their current level of $80 per member per annum. Option 2 Expand the exercise studio. The capital cost of this would be $360 000.The expected effect on membership numbers for the next three years is as follows Probability ....................Effect on membership numbers 0.4 ................................Remain at their current level of 6000 members per annum 0.6 ................................Increase to 6500 members per annum The effect on operational costs for the next three years is expected to be: Probability ....................Effect on operational costs 0.5 ................................Increase to $120 per member per annum 0.5 ................................Increase to $180 per member per annum Required: (a) Using the criterion of expected value, prepare and fully label a decision tree that shows the two options available to GB. Recommend the decision that GB should make. Ignore time value of money. (b) Calculate the maximum price that GB should pay for perfect information about the expansion’s exact effect on MEMBERSHIP NUMBERS. (c) Briefly discuss the problems of using expected values for decisions of this nature.
Gym Bunnies (GB) is a health club. It currently has 6000 members, with each member paying a subscription fee of $720 per annum. The club is comprised of a gym, a swimming pool and a small exercise studio.
A competitor company is opening a new gym in GB’s local area, and this is expected to cause a fall in GB’s membership numbers, unless GB can improve its own facilities.
Consequently, GB is considering whether or not to expand its exercise studio in a hope to improve its membership numbers. Any improvements are expected to last for three years.
Option 1
No expansion. In this case, membership numbers would be expected to fall to 5250 per annum for the next three years.
Operational costs would stay at their current level of $80 per member per annum.
Option 2
Expand the exercise studio. The capital cost of this would be $360 000.The expected effect on membership numbers for the next three years is as follows
Probability ....................Effect on membership numbers
0.4 ................................Remain at their current level of 6000 members per annum
0.6 ................................Increase to 6500 members per annum
The effect on operational costs for the next three years is expected to be:
Probability ....................Effect on operational costs
0.5 ................................Increase to $120 per member per annum
0.5 ................................Increase to $180 per member per annum
Required:
(a) Using the criterion of expected value, prepare and fully label a decision tree that shows the two options available to GB. Recommend the decision that GB should make.
Ignore time value of money.
(b) Calculate the maximum price that GB should pay for perfect information about the expansion’s exact effect on MEMBERSHIP NUMBERS.
(c) Briefly discuss the problems of using expected values for decisions of this nature.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps with 3 images
