Suppose we are considering the question of how much capacity to build in the face of uncertain demand. Assume that the cost is $20 per unit of lost sales due to insufficient capacity. Also assume that there is a cost of $7 for each unit of capacity built. The probability of various demand level is as follows:
|
Demand-X Units
|
Probability of X
|
|
0
|
0.05
|
|
1
|
0.1
|
|
2
|
0.15
|
|
3
|
0.2
|
|
4
|
0.2
|
|
5
|
0.15
|
|
6
|
0.1
|
|
7
|
0.05
|
How many units of capacity should be built to minimize the total cost of providing capacity plus lost sales?