A Pacific Northwest Lumber Company Is Considering the Expansion of One

question 7

Essay

A Pacific Northwest lumber company is considering the expansion of one of its mills.The question is whether to do it now,or wait for one year and re-consider.If they expand now,the major factors of importance are the state of the economy and the level of interest rates.The combination of these two factors results in five possible situations.If they do not expand now,only the state of the economy is important and three conditions characterize the possibilities.The following table summarizes the situation: $\begin{array}{l}\begin{array}{llcc}&&Probabilities &Revenues\\\underline{\text { Expand }}\\&\text { very favorable } & .2 & \$ 80,000 \\&\text { favorable } & .2 & \$ 60,000 \\&\text { neutral } & .1 & \$ 20,000 \\&\text { unfavorable } & .3 & -\$ 20,000 \\& \text { very unfavorable } & .2 & -\$ 30,000 \\\underline{\text { Don't expand }} & & \\ &\text { expansion } & .2 & \$ 50,000 \\&\text { steady } & .5 & \$ 30,000 \\&\text { contraction } & .3 & \$ 10,000\end{array}\end{array}$
a. Draw the decision tree for this problem.
b. What is the expected value for expanding?
c. What is the expected value for not expanding?
d. Based on expected value, what should the company's decision(s) be?

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Definitions:

Unit Production Costs

The total cost associated with producing a single unit of a product, including materials, labor, and overhead.

Conversion Cost

The blend of work and indirect expenses used to transform raw materials into completed goods.

Work in Process

Refers to the cost of unfinished goods in the manufacturing process including labor, raw materials, and overhead costs.

Total Conversion Costs

Total conversion costs are the sum of labor and overhead expenses incurred to convert raw materials into finished goods.