Question: SS KUNIANG, PART II
This case asks you to find the optimal amount for NEES to bid for the SS Kuniang (page 114). Before doing so, though, you need additional details. Regarding the Coast Guard's (CG) salvage judgment, NEES believes that the following probabilities are an appropriate representation of its uncertainty about the salvage-value judgment:
The obscure-but-relevant law required that NEES pay an amount (including both the winning bid and refitting cost) at least 1.5 times the salvage value for the ship in order to use it for domestic shipping. For example, if NEES bid $3.5 million and won, followed by a CG judgment of $4 million, then NEES would have to invest at least $2.5 million more: $3.5 + $2.5 = $6 = $4 × 1.5. Thus, assuming NEES submits the winning bid, the total investment amount required is either the bid or 1.5 times the CG judgment, whichever is greater.
As for the probability of submitting the highest bid, recall that winning is a function of the size of the bid; a bid of $3 million is sure to lose, and a bid of $10 million is sure to win. For this problem, we can model the probability of winning (P) as a linear function of the bid: P=(Bid-$3million)/ ($7 million). Finally, NEES's values of $18 million for the new ship and $15 million for the tug-barge alternatives are adjusted to reflect differences in age, maintenance, operating costs, and so on. The two alternatives provide equivalent hauling capacity. Thus, at $15 million, the tug-barge combination appears to be the better choice.
1. Reasonable bids may fall anywhere between $3 and $10 million. Some bids, though, have greater expected values and some less. Describe a strategy you can use to find the optimal bid, assuming that NEES's objective is to minimize the cost of acquiring additional shipping capacity. (This question asks you only to describe an approach to finding the optimal bid.)
2. Use your structure of the problem (or one supplied by the instructor), with the details supplied previously, to find the optimal bid.