A Company Manufactures Specialty Pollution-Sensing Devices for the Offshore Oil

question 8

Essay

A company manufactures specialty pollution-sensing devices for the offshore oil industry. One particular device has reached maturity, and the company is considering whether to replace it with a newer model. Technologies have not changed dramatically, so the new device would have similar functionality to the existing one, but would be smaller and lighter in weight. The firm's three choices are: keep the old model; design a replacement device with internal resources; and purchase a new design from a firm that is one of its suppliers. The market for these devices will be either "receptive" or "neutral" of the replacement model. The financial estimates are as follows: Keeping the old design will yield a profit of $6 million dollars. Designing the replacement internally will yield $10 million if the market is "receptive," but a $3 million loss if the market is "neutral." Acquiring the new design from the supplier will profit $4 million under "receptive," $1 million under "neutral." The company feels that the market has a 70% chance of being "receptive" and a 30% chance of being "neutral." Draw the appropriate decision tree. Calculate expected value for all courses of action. What action yields the highest expected value?

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Definitions:

Traceable Fixed Expense

A fixed expense that can be directly linked to a specific department, product, or activity without any allocation.

Net Operating Income

The profit generated from a business's operations after subtracting operating expenses from operating revenues.

Price Hike

An increase in the price of goods or services, often due to higher production costs or increased demand.

Traceable Fixed Expense

Fixed costs that can be directly linked to a specific business department or segment, aiding in performance evaluation.