20130265
|
Nada Abdel Nasser
|
20130258
|
Merit Magdy Mohammed
|
20130271
|
Nehad Ali
|
20130089
|
Eman Abd El shafy
|
Stygian Chemical Industries
The company Stygian Chemical Industries must decide whether to build a small plant or a large one to manufacture a new product with an expected market life of ten years. The decision hinges on what size the market for the product will be.
- Decision#1 The Company must decide between a large and a small plant.
- But if the company chooses to build a small plant and then finds demand high during the initial period, it can in two years—at Decision #2—choose to expand its plant.
1. It is estimated further that a large plant would cost $3 million to put into operation
2. A small plant would cost $1.3 million
3. The expansion of the small plant would cost an additional $2.2 million.
4. A large plant with high volume would yield $1,000,000 annually in cash flow.
2. A large plant with low volume would yield only $100,000 because of high fixed costs and inefficiencies.
3. A small plant with low demand would be economical and would yield annual cash income of $400,000.
4. A small plant, during an initial period of high demand, would yield $450,000 per year, but this would drop to $300,000 yearly in the long run because of competition. (The market would be larger than under Alternative 3, but would be divided up among more competitors.)
5. If the small plant were expanded to meet sustained high demand, it would yield$700,000 cash flow annually, and so would be less efficient than a large plant built initially.
6. If the small plants were expanded but high demands were not sustained, estimated annual cash flow would be $50,000.
- Marketing estimates indicate a 60% chance of a large market in the long run and a 40% chance of a low demand, developing initially as follows:
Initially high demand, sustained high=60%
Initially high demand, long-term low=10%
Initially low and continuing low=30%
Initially low and subsequently high=0%
Therefore, the chance that demand initially will be high is 70% (60 + 10). If demand is high initially, the company estimates that the chance it will continue at a high level is 86% (60 ÷ 70). Comparing 86% to 60%, it is apparent that a high initial level of sales changes the estimated chance of high sales in the subsequent periods.
Similarly, if sales in the initial period are low, the chances are 100% (30 ÷ 30) that sales in the subsequent periods will be low.
Options of decision#1
Yield
|
probability
|
Chance event
|
Choice
|
1000,000(10years)
|
0.6
|
High average demand
|
Build Large planet
|
1000,000(2years)
100.000(8years)
|
0.1
|
High initial, low average demand
| |
100,000(10years)
|
0.3
|
Low average demand
| |
450,000(2years)
|
0.7
|
High initial demand
|
Build small planet
|
400,000(10years)
|
0.3
|
Low initial demand
|
Options of decision#2
Yield
|
probability
|
Chance event
|
Choice
|
700,000(8years)
|
0.86
|
High average demand
|
Expansion of small planet
|
50,000(8years)
|
0.14
|
Low average demand
| |
300,000(8years)
|
0.86
|
High average demand
|
No-Expansion of small planet
|
400,000(8years)
|
0.14
|
Low average demand
|
In the event that the company building for both large planet and small planet.
- What do you suggest the company should do and why?
- What are the downside and the upside of your suggested course of action?
Solution
Step #1
. path to terminal (4), Build large planet cost($3000,000),with high average demand yield($1000,000) at 10 years, total profit=-3000,000+1000,000(10 years)=$7000,000.
. path to terminal (5), Build large planet cost($3000,000),with initial high yield($1000,000) at 2 years ,low average demand yield($100,000) at 8 years, total profit=-3000,000+(1000,000(2 years)+100,000(8 years)= -$200,000.
. Path to terminal (6), Build large planet cost ($3000, 000), with low average demand yield ($100,000) at 10 years, total profit=-3000, 000+100,000(10 years) = -$2000, 000.
. path to terminal (11), Build small planet cost($1300,000),with initial high average demand yield($450,000) at 2 years, and we will expand the small planet with cost($2200,000),if high average demand yield($700,000) at 8years, total profit=-1300,000+450,000(2 years)-2200,000+700,000(8 years)=$3000,000.
. path to terminal (12), Build small planet cost($1300,000),with initial high average demand yield($450,000) at 2 years, and we will expand the small planet with cost($2200,000),if low average demand yield($50,000) at 8 years,total profit=-1300,000+450,000(2 years)-2200,000+50,000(8 years) = -$2200,000.
. path to terminal (13), Build small planet cost($1300,000),with initial high average demand yield($450,000) at 2 years, and we will not expand the small , if high average demand yield($300,000) at 8 years, total profit=-1300,000+450,000(2 years)+300,000(8 years)=$2000,000.
. path to terminal (14), Build small planet cost($1300,000),with initial high average demand yield($450,000) at 2 years, and we will not expand the small , if low average demand yield($400,000) at 8 years, total profit=-1300,000+450,000(2 years)+400,000(8 years)=$2800,000.
. path to terminal (8), Build small planet cost($1300,000),with low average demand yield($400,000) at 10 years, , total profit=-1300,000+400,000(8 years)=$2700,000.
-Hence we can arrive at the table below indicating for each branch the total profit involved in that branch from the initial node to the terminal node.
Terminal node Total profit
4 $7000, 000
5 -$200, 000
6 -$2000, 000
11 $3000, 000
12 -$2200, 000
13 $2000, 000
14 $2800, 000
8 $2700, 000
We can now carry out the second step of the decision tree solution procedure where we work from the right-hand side of the diagram back to the left-hand side.
Step #2
.For chance node 9 the EMV is 0.86(3000, 000) + 0.14(-2200, 000) =$2,272,000.
.For chance node 10 the EMV is 0.86(2000, 000) + 0.14(2800, 000) =$2,112,000.
Hence the best decision at decision node 7 is to expand the small planet at a profit=$2,272,000.
.For chance node 3 the EMV is 0.7(2,272,000) + 0.3(2700, 000) =$2,400,400.
.For chance node 2 the EMV is 0.6(7,000,000) + 0.1(-200, 000) +0.2(-2,000,000) = $3,580,000.
Hence the best decision at decision node 1 is to build the large planet at a profit=$3,580,000.
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