A plant manager wants to know how much he should be willing to pay for perfect market research. Currently there are two states of nature facing his decision to expand or do nothing. Under favorable market conditions the manager would make $100,000 for the large plant and $5,000 for the small plant. Under unfavorable market conditions the large plant would lose $50,000 and the small plant would make $0. If the two states of nature are equally likely, how much should he pay for perfect information?

A) $0
B) $25,000
C) $50,000
D) $100,000
E) unable to determine

The expected value of the decision without perfect information is:
E(DO NOTHING) = (0.5)($0) + (0.5)($5,000) = $2,500
E(EXPAND) = (0.5)($100,000) + (0.5)(-$50,000) = $25,000

The expected value of the decision with perfect information is:
If the manager finds out that the market will be favorable, he will choose to expand the large plant and make $100,000. If the market will be unfavorable, he will choose to do nothing and only make $5,000. Therefore, the manager would be willing to pay up to the difference between the expected value with perfect information and the expected value without perfect information:
E(PERFECT INFO) = (0.5)($100,000) + (0.5)($5,000) = $52,500
Max amount to pay for perfect info = E(PERFECT INFO) - E(DO NOTHING) = $52,500 - $2,500 = $25,000.
Therefore, the manager should be willing to pay up to $25,000 for perfect information.