Reference no: EM132462575

Question 1: A tun must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a .40 probability that demand will be low and a .60 probability that demand will be high.

• If the firm builds a small facility and demand turns out to be low, the net present value will be $54 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $60 million or expand greatly for a net present value of $70 million, however this will incur a further cost of 35 million.

• The firm could build a medium sized facility, if demand is low the net present value will be estimated at $33 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $56 million, or it can expand and realize a net present value of $60 million, and incur further costs of 15 million.

• If the firm builds a large facility and demand is low, the net present value will be -$30 million, whereas high demand will result in a net present value of $80 million.

Required :

Problem a) Draw a net work diagram to illustrate this infonnation show calculations where necessary.

Problem b) What is the best alternative for the finn and why? 

Problem c) Calculate the EVPI.

Question2: A manager must decide how many machines of a certain type to buy. The machines will be used to manufacture a new gear for which there is increased demand. The manager has narrowed the decision to two alternatives: Buy one machine or buy two machines. If only one machine is purchased and the demand is more than it can handle, a second machine can be purchased at a later time. However the cost per machine would be lower if the two machines were purchased at the same time. The estimated probability of the low demand is 0.30, and the estimated probability of high demand is 0.70. The net present value associated with the purchase of two machines initially is $75,000 if demand is low and $130,000 if demand is high. The net present value for one machine and low demand is $90,000. If demand is high there are three options. One option is to do nothing, which would have a net present value of $90,000. A second option is to subcontract; that will have a net present value of S110,000. The third option is to purchase a second machine. This option would have a net present value of $100,000.

Problem 1: How many machines should the manager purchase initially? Use a decision tree to analyze this problem.