Reference no: EM131754432

Question: A small engineering firm is under increasing pressure from foreign competitors and is considering a number of strategic options. One of these relates to changing over from the existing production process to one which is completely automated. The firm has narrowed down its choices regarding this option to two possibilities. The first, System I, is that the firm could install a production process using computer-controlled production equipment purchased from the Far East. This system is expected to have a marked impact on the firm's operating costs. However, the system would take three years to design and install and would cost some £2.5 million. The projected cost savings are around £1 million a year once the system is operative. The system is expected to have a useful life of ten years. However, the Far East company which would design and supply the equipment is new to the engineering company and it has been assessed that this course of action has a probability of only 55 per cent of performing satisfactorily.

The second possibility is that the firm could collaborate with the production engineering department at the local university, which is at the leading edge of research in this field. This production system, System II, would be designed to run in parallel with the first, System I, and would cost £1 million to design and develop. However, System II would take three years to implement. The university estimates that it has a 75 per cent chance of coming up with an appropriate system. The problem is that System II is basically for ‘insurance' in case System I fails to perform as required. If System I does work satisfactorily, the expenditure on System II will have been for nothing. To complicate the issue the decision to develop System II does not need to be taken now: it can be taken at any time during the ten-year life of System I but bearing in mind that System II takes three years to develop. Ignoring the time consequences of expenditure and cost savings, construct a decision tree for this problem and advise the company on a suitable course of action.