The “Ferrara Calabria” is an outdoor high-end seafood restaurant located in a small resort town on the shore of the Mediterranean Sea. The restaurant is considering whether to sign a contract with a hugely popular jazz quintet “Solerno Jazz” that would play for 12 summer weeks from June to August 2021. “Ferrara Calabria has to choose between two options: the contract for performance on Friday nights and the contract for performance on Saturday & Sunday nights. The contract should be signed by the end of December 2020. The “Solerno Jazz” consists of five musicians whose charges per performance on Friday night are the following: Piano EUR 195 Saxophone EUR 175 Drums EUR 160 Guitar EUR 200 Vocalist EUR 230 Charges for Saturday performance are higher by 70% whereas for Sunday performance – 2 times higher compared with Friday prices The restaurant’s accountant Emily Bronte has been asked to evaluate the financial effects of the decision to hire the jazz band. The accountant has made the following estimates An increase in the number of clients attending the restaurant on a day of “Solerno Jazz” performance is uncertain, but it has been initially hestimated as follows: Clients 5 Friday Probability 10% 25 % 30% 35% Saturday Probability Clients 15 % 15 20 % 20 30 40 % 25 Sunday Probability Clients 20 % 15 25 25 30.96 30 25 35 25 % 25 15
Using available data on revenues earned in previous years, Mrs. Bronte has calculated that the average amount of money spent by each client was EUR 95 on Fridays, EUR 102 on Saturdays and EUR 109 on Sundays. As live music would induce clients to stay longer and spend more money, Mrs. Bronte budgets a 20 % increase in their Friday’s bills and a 25 % increase in their Saturday’s and Sunday’s bills in summer 2021
To accommodate a stage for the jazz quintet and additional clients whom the restaurant wants to attract the “Ferrara Calabria” needs more room. It can be rented from the landlord at a daily price of EUR 220 per Friday and EUR 300 per Saturday and Sunday. Due to a high demand for property in summer months, a lease contract must be signed by December 15, 2020. Mrs. Bronte believes that “Ferrara Calabria” decision to hire the jazz band will provoke an immediate reaction from competing restaurants who will struggle against a potential decrease in their market share. There is 55 % probability that competitors will react if the Solerno Jazz” is hired on Fridays and 75 % probability that their reaction will follow if the Solerno Jazz” is hired on Saturdays and Sundays. The impact of competitors’ activities on “Ferrara Calabria” revenues from additional clients is estimated as follows: 35 % probability that the “Ferrara Calabria” will fail to attract any additional clients, 35 % probability that its revenues will constitute only 50 % of the budgeted amount: 30 % probability that competitors’ activities will not have any impact on “Ferrara Calabria” revenues.
(b) Based on the calculated expected values, determine whether the “Ferrara Calabria” should hire the jazz band “Solerno Jazz” or maintain the current status quo. If the restaurant decides to choose the corbact, which contract should it choose and why? (30 marks) (c) With reference to this case study of the Ferrara Calambria”, explain how the drawbacks of a decision tree method might limit its usefulness to decision making under risk. (10 marks)
Expert Answer