A firm is weighing three capacity alternatives: small, medium, and large job shop. Whatever capacity choice is made, the market demand for the firm's product can be "moderate" or "strong." The probability of moderate market demand is estimated to be 0.4; the probability of strong market demand is estimated to be 0.6. The anticipated profits are as follows:

a. Small job shop, moderate market = $24,000; Small job shop, strong market =$54,000.
b. Medium job shop, moderate market = $20,000; medium job shop, strong market = $64,000.
c. Large job shop, moderate market = -$2,000; large job shop, strong market = $96,000.

Which capacity choice should the firm make?

The firm should capacity "c" since it has the highest expected profit of $58,400.

Explanation:

The expected profit of each capacity will be calculated by adding together the multiplication of the profit from each market demand and its probability. The decision is then to the capacity that has the highest expected profit as provided as follows:

a. Expected profit of capacity "a" = ($24,000 × 0.4) + ($54,000 × 0.6) = $9,600 + $32,400 = $42,000.

b. Expected profit of capacity "b" = ($20,000 × 0.4) + ($64,000 × 0.6) = $8,000 + $38,400 = $46,400.

c. Expected profit of capacity "c" = ($2,000 × 0.4) + ($96,000 × 0.6) = $800 + $57,600 = $58,400.

The firm should capacity "c" since it has the highest expected profit of $58,400.

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