Your company is considering whether it should tender for two contracts (MS1 and MS2) on offer from a government department for the supply of certain components. The company has three options:
. tender for MS1 only; or
. tender for MS2 only; or
. tender for MS1 and MS2.
If tenders are to be submitted the company will incur addition costs. These costs will have to be entirely recouped from the contract price. The risk, of course is that if a tender is unsuccessful the company will have made a loss.
The cost for tendering for contract MS1 only is $50000. The component supply cost if the tender is successful would be $18000.
The cost for tendering for contract MS2 only is $14000. The component supply cost if the tender is successful would be $12000.
The cost for tendering for both contracts MS1 and contract MS2 is $55000. The component supply cost if the tender is successful would be $24000.
For each contract, possible tender prices have been determined. In addition, subjective assessments have been made of the probability of getting the contract with a particular tender price as shown below. Note here that the company can only submit one tender and cannot, for example, submit two tenders (at different prices) for the same contract.
Option Possible tender prices ($) Probability of getting contract
MS1 only 130000 0.20
115000 0.85
MS2 only 70000 0.15
65000 0.80
60000 0.95
MS1 an MS2 190000 0.05
140000 0.65
In the event that the company tenders for both MS1 and MS2 it will either win both contracts (at the prices shown above) or no contract at all.
a) Draw a decision tree for the problem and carry out an analysis to determine what the company should do and why? (16mks)
b) What are the downside and the upside of your suggested course of action? (4mks)
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