International Guidance and Controls

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International Guidance and Controls Let S be the cost of project lateness including direct and indirect costs. According to the case the direct cost of lateness is $0.8m per month of lateness, and the indirect cost of lateness is the cost of lost reputation. As an example, if the project is two months late and the cost of lost reputation is estimated to be $2m, then S is $3.6m. Let: SW Only = software only; HW Now = expand hardware now; Delay HW = delay hardware decision; OT = project finished on time; Late = project finished late; FP = favorable software progress in the first five months; NP = learning nothing new in the first five months; and UP = unfavorable software progress in the first five months.…show more content…
For S ≥ $3.405m, choose HW Now.  Suppose that S is $1.6m. Now the decision tree is what you see in Figure 3. The overall recommendation is: Choose Delay HW. If FP or NP, then choose SW Only; if UP then choose HW Now. The expected cost of the optimal decision is 3.2906. The risk profile is: SW Only Cost (million $) Probability 3 0.8 4.6 0.2 HW Now Cost (million $) Probability 3.5 1 Delay HW Cost (million $) Probability 3 0.744 3.75 0.14 4.6 0.116 Calculation of EVPI: Suppose that S is $1.6m and we want to compute the EVPI (expected value of perfect information) where the information concerns whether the project would be late or not. We need to consider two scenarios: one where no information is available, and the other where perfect information is available. Note that the Delay HW choice can be ignored in this analysis because delaying the hardware decision is akin to collecting some information on whether the project would be finished on time or not. When no information is available the decision tree is as shown in Figure 4. The expected cost is $3.32m. When perfect information is available the decision tree is as shown in Figure 5. The expected cost is $3.1m. With perfect information the expected cost goes down by $3.32 - $3.1m = $0.22m = $220,000. Hence, EVPI = $220,000. We can also calculate EVPI by first calculating the VPI of each piece of perfect information. Note
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