Question

A manufacturing company is considering expanding its production capacity to meet a growing demand for its product line of air fresheners. The alternatives are to build a new plant, expand the old plant, or do nothing. The marketing department estimates a 35 percent probability of a market upturn, a 40 percent probability of a stable market, and a 25 percent probability of a market downturn. Georgia Swain, the firm's capital appropriations analyst, estimates the following annual returns for these alternatives:

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​	Market Upturn	Stable Market	Market Downturn
​
Build new plant	$690,000	$(130,000)	$(150,000)
Expand old plant	490,000	(45,000)	(65,000)
Do nothing	50,000	0	(20,000)

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a. Construct a decision tree to analyze these decision alternatives.

b.   What should the company do based on expected value?

c. Assume that the probability of a market upturn is 25% and the probability of the market being stable is 50%, does this change your recommendation and if so, what is the new recommendation?

Answer 1

a.

b.

Based on the maximum expected value, the company should build a new plant with a maximum expected value = $152,000

c.

Now,

Based on the maximum expected value, the company should expand the existing plant with a maximum expected value = $83,750