Exhibit 11-2 Suppose We Want to Choose Capacity for a Plant That

question 14

Essay

Exhibit 11-2
Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
-[Part 4] Refer to Exhibit 11-2.Are there any simulations which indicated there was a chance of getting negative NPV
Briefly explain in one sentence.

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Definitions:

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Extraneous Variable

Any variable that is not intentionally studied within an experiment that can affect the outcome of the research if not controlled.

Dependent Variable

The variable in an experiment that is observed and measured to see how it is affected by the independent variable.

Operational Definition

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