Could you please help out with this problem A company manufa

Could you please help out with this problem!

A company manufactures stamped steel products. Increasingly, foreign producers are undercutting the companys price for these stampings, and the company is studying the technology of its production capacity to determine if it should be upgraded to become competitive with foreign firms. If production processes are automated, the net present value of the returns (net present value means that the returns are expressed in terms of todays dollars) to the company is dependent on the market for the plants products:

Process

Market Level

Likelihood

Return

Automated

High

0.1

$4,000,000

Med

0.5

$2,600,000

Low

0.4

$1,500,000

If the company decides to do nothing now and review the situation in five years, two alternatives will probably be present then- continue operating with the existing production processes or shut the plant down and liquidate its assets. If the plant continues to be operated in its existing condition after five years, the net present value of the returns is dependent on the market for the plants products at that time:

If the company shuts the plant down and liquidates its assents after five years, the net present value of the returns is estimated to be $2,000,000.

Alternative

Market Level

Likelihood

Return

Do nothing now, continue operating in existing conditions

High

0.3

$3,000,000

Med

0.4

$2,500,000

Low

0.3

$2,000,000

Use a decision tree analysis and recommend a course of action for the company.

What returns should the company actually expect from following your recommendations.

Solution

Under the decision tree analysis, there are two types of nodes, one decision nodes represented with square boxes which represents alternatives/options available to the decision maker and second one denoted by circles- events node representing the likely states/outcomes related to the alternative/option selected.

In the given question, firstly company is required to make choice between existing operations or go far automatic process. Secondly if continue with existing system, review after five years to make a choice between shutting down and continuation of the existing operations.

Evaluation of the decision tree is backward process, strating calculations of expected outcomes with the last event nodes, so let us first compare the two options of five year hence

1. Do nothing now, continue operating in existing conditions--Outcome Expected Return = .3*3,000,000 + .4*2,500,000 + .3*2,000,000 =$2,500,000

2. Shut the plant and liquidate-- Outcome Expected Return = $2,000,000

Therefore the better choice is to continue as expected return is greater in this case.

Now we evaluate the option of automated process Outcome expected Return = .1*4,000,000 + .5*2,600,000 + .4*1,500,000 = $2,300,000

Between the existing and automated, the expected return is more for existing process with no change, therefore the final decision is Do nothing now, continue operating in existing conditions.

In the event of changed likelihood of market levels as mentioned for automated process, the expected returns for existing process will be (.1*3,000,000+.5*2,500,000+.4*2,000,000) $2,350,000

Therefore the ultimate decision is in favor of Do nothing and continue with existing process