Answered: FIGURE 13.18 DECISION TREE FOR…

Purchasing and Supply Chain Management

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ISBN:9781285869681

Author:Robert M. Monczka, Robert B. Handfield, Larry C. Giunipero, James L. Patterson

Publisher:Robert M. Monczka, Robert B. Handfield, Larry C. Giunipero, James L. Patterson

ChapterC: Cases

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Problem 5.3SD: Scenario 4 Sharon Gillespie, a new buyer at Visionex, Inc., was reviewing quotations for a tooling...

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$### Decision Analysis for R&D Projects: Hemmingway, Inc. Case Study **Problem Statement:** Hemmingway, Inc. is considering a $5 million research and development (R&D) project. While the profit projections appear promising, the company president is concerned due to the 0.50 probability of the R&D project being successful. Additionally, even with a successful R&D project, a new production facility, costing $20 million, will be required to manufacture the product. There are uncertainties about demand and the resultant profits even if the facility is built. Alternatively, Hemmingway, Inc. can sell the rights to the product for $25 million if the R&D project is successful, thereby avoiding the need to build the new production facility. **Decision Tree Analysis:** The accompanying decision tree (Figure 13.18) is crucial in this analysis. It projects the potential profit for each outcome: - For high demand, the revenue projection is $59 million. - Considering the costs of the R&D project ($5 million) and the production facility ($20 million), the profit in this scenario is calculated as: \[ \text{Profit} = \$59\text{ million} - \$5\text{ million} - \$20\text{ million} = \$34\text{ million} \] Branch probabilities for different chance events are also outlined in the decision tree. **Key Considerations:** a. **Decision Tree Analysis:** - Determine whether Hemmingway, Inc. should undertake the R&D project. - If the R&D project proceeds and is successful, determine the subsequent steps for maximizing profits. - Calculate the expected value of the strategy. b. **Selling Rights Evaluation:** - Assume Hemmingway, Inc. opts to sell the rights to the product. - Determine the minimum selling price beneficial for the company compared to building the production facility. c. **Risk Profile Development:** - Create a risk profile for the optimal strategy choice. - Assess the potential risks and returns through probabilistic analysis. By carefully analyzing these aspects, Hemmingway, Inc. can make an informed decision regarding whether to pursue the R&D project, build the new production facility, or sell the product rights. Each route has its own set of financial implications and risks, which must be evaluated comprehensively.$

Transcribed Image Text:### Decision Analysis for R&D Projects: Hemmingway, Inc. Case Study **Problem Statement:** Hemmingway, Inc. is considering a $5 million research and development (R&D) project. While the profit projections appear promising, the company president is concerned due to the 0.50 probability of the R&D project being successful. Additionally, even with a successful R&D project, a new production facility, costing $20 million, will be required to manufacture the product. There are uncertainties about demand and the resultant profits even if the facility is built. Alternatively, Hemmingway, Inc. can sell the rights to the product for $25 million if the R&D project is successful, thereby avoiding the need to build the new production facility. **Decision Tree Analysis:** The accompanying decision tree (Figure 13.18) is crucial in this analysis. It projects the potential profit for each outcome: - For high demand, the revenue projection is $59 million. - Considering the costs of the R&D project ($5 million) and the production facility ($20 million), the profit in this scenario is calculated as: \[ \text{Profit} = \$59\text{ million} - \$5\text{ million} - \$20\text{ million} = \$34\text{ million} \] Branch probabilities for different chance events are also outlined in the decision tree. **Key Considerations:** a. **Decision Tree Analysis:** - Determine whether Hemmingway, Inc. should undertake the R&D project. - If the R&D project proceeds and is successful, determine the subsequent steps for maximizing profits. - Calculate the expected value of the strategy. b. **Selling Rights Evaluation:** - Assume Hemmingway, Inc. opts to sell the rights to the product. - Determine the minimum selling price beneficial for the company compared to building the production facility. c. **Risk Profile Development:** - Create a risk profile for the optimal strategy choice. - Assess the potential risks and returns through probabilistic analysis. By carefully analyzing these aspects, Hemmingway, Inc. can make an informed decision regarding whether to pursue the R&D project, build the new production facility, or sell the product rights. Each route has its own set of financial implications and risks, which must be evaluated comprehensively.

### Figure 13.18: Decision Tree for Hemmingway, Inc.

This decision tree illustrates the potential pathways and outcomes for Hemmingway, Inc. regarding a Research and Development (R&D) project. The decision-making process is broken down into several steps, with associated probabilities and potential profit or loss outcomes. Here is a detailed explanation of the tree:

1. **Initial Decision - Start R&D Project ($5 million investment)**:
- Node 1 represents the decision whether to start the R&D project.
- If the decision is to **start the R&D project** (moving to Node 2), an investment of $5 million is required.
- If the decision is to **not start the R&D project**, the process ends at this point with a profit of $0 (indicated on the bottom branch).

2. **Outcome of the R&D Project**:
- At Node 2, there is uncertainty in the success of the R&D project.
- There is a **50% probability (0.5)** that the project will be **successful** (moving to Node 3).
- There is a **50% probability (0.5)** that the project will be **unsuccessful**, leading to a loss of $5 million (indicated on the lower branch off Node 2).

3. **Successful R&D Project**:
- If the R&D project is successful and moves to Node 3, two options are considered:
- Selling the rights, which results in an immediate profit of $20 million (upper branch off Node 3).
- Building a facility, entailing a cost of $20 million to enter production and subsequent demand uncertainty (moving to Node 4).

4. **Building Facility and Market Demand**:
- At Node 4, there are three possible market demand scenarios, each with associated probabilities and profit outcomes:
- **High Demand**:
- Probability: **50% (0.5)**
- Profit: **$34 million**
- **Medium Demand**:
- Probability: **30% (0.3)**
- Profit: **$20 million**
- **Low Demand**:
- Probability: **20% (0.2)**
- Profit: **$10 million**

By following the branches from decision points to final outcomes, this decision tree helps visualize the strategic options and potential financial

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FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Successful 0.5 Start R&D Project ($5 million), Not Successful 0.5 Do Not Start the R&D Project 1-1 Building Facility ($20 million) Sell Rights Profit ($ millions) 34 20 10 20 -5 High Demand 0.5 Medium Demand 0.3 Low Demand 0.2