A Chemical Company Is Trying to Decide Whether to Build

question 12

Essay

A chemical company is trying to decide whether to build a pilot plant now for a new chemical process or to build the full plant now. If they build a pilot plant now, they could expand it later to a full plant or license the plant to another company. It would cost them $2 million to build the pilot plant and another $2 million later to expand it. If they build the full plant now it would cost $3.5 million to construct. The returns they expect to get from the full production plant depend upon the market.They estimate there is a 60% chance the market will be robust, a 30% chance it will remain stable, and a 10% chance it will become stagnant. The returns are estimated to be $5 million if it is robust, $3 million if it is stable, and $1 million if it is stagnant.Before they expand the pilot plant, they plan to conduct a comprehensive study. Based on past experience, they expect the study to report a 60% chance of favorable outcome for expansion and a 40% unfavorable chance. In either case, they should decide whether to expand to a full plant or license the pilot plant. If the report is favorable and they license it, they expect to get $3 million. However, if the report is unfavorable and they license it, they will only get $1 million.
a. Using decision tree analysis, what is the expected value for building the full plant now?
b. Using decision tree analysis, what is the value of the decision on expanding the pilot plant assuming the report is favorable?
c. What should the company do, and what is the expected value of that decision?

---

Definitions:

Circadian Rhythm

A natural, internal process that regulates the sleep-wake cycle and repeats roughly every 24 hours, affecting physical, mental, and behavioral changes in living organisms.

Pineal Gland

A small, pine-cone-shaped endocrine gland in the brain that produces and secretes the hormone melatonin, which regulates sleep patterns.

Hypothalamus

A region of the brain below the thalamus that coordinates both the autonomic nervous system and the activity of the pituitary, controlling body temperature, thirst, hunger, and other homeostatic systems.

REM Sleep

A phase of sleep characterized by rapid eye movements, vivid dreaming, and increased brain activity.