A Manufacturer Must Decide Whether to Build a Small or a Large

question 105

Essay

A manufacturer must decide whether to build a small or a large plant at a new location. Demand at the location can be either low or high, with probabilities estimated to be 0.4 and 0.6, respectively. If a small plant is built, and demand is high, the production manager may choose to maintain the current size or to expand. The net present value of profits is $223,000 if the firm chooses not to expand. However, if the firm chooses to expand, there is a 50% chance that the net present value of the returns will be 330,000 and a 50% chance the estimated net present value of profits will be $210,000. If a small facility is built and demand is low, there is no reason to expand and the net present value of the profits is $200,000. However, if a large facility is built and the demand turns out to be low, the choice is to do nothing with a net present value of $40,000 or to stimulate demand through local advertising. The response to advertising can be either modest with a probability of .3 or favorable with a probability of .7. If the response to advertising is modest, the net present value of the profits is $20,000. However, if the response to advertising is favorable, then the net present value of the profits is $220,000. Finally, if the large plant is built and the demand happens to be high, the net present value of the profits $800,000.
-Draw a decision tree and determine the payoff for each decision and event node. Which alternative should the manufacturer choose?

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Definitions:

Melatonin

A hormone produced by the pineal gland in the brain, involved in regulating sleep cycles and circadian rhythms.

Thyroid Hormone

Hormones produced by the thyroid gland that regulate metabolism, energy generation, and neuronal development.

Parathyroid Hormone

A hormone produced by the parathyroid glands that regulates calcium levels in the blood and bone metabolism.