A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.20 probability that demand will be low and a 0.80 probability that demand will be high. If the firms builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium size facility as a hedge: if demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million. Analyze and prepare a decision tree.

A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.20 probability that demand will be low and a 0.80 probability that demand will be high. If the firms builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $42 million or expand greatly for a net present value of $48 million. The firm could build a medium size facility as a hedge: if demand turns out to be low, its net present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $46 million, or it could expand and realize a net present value of $50 million. If the firm builds a large facility and demand is low, the net present value will be -$20 million, whereas high demand will result in a net present value of $72 million. Analyze and prepare a decision tree.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

SUBJECT: Engineering Economics

Number 6

Question 6
A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's
report indicates a 0.20 probability that demand will be low and a 0.80 probability that demand will
be high.
If the firms builds a small facility and demand turns out to be low, the net present value will be
$42 million. If demand turns out to be high, the firm can either subcontract and realize the net
present value of $42 million or expand greatly for a net present value of $48 million.
The firm could build a medium size facility as a hedge: if demand turns out to be low, its net
present value is estimated at $22 million; if demand turns out to be high, the firm could do nothing
and realize a net present value of $46 million, or it could expand and realize a net present value of
$50 million.
If the firm builds a large facility and demand is low, the net present value will be -$20 million,
whereas high demand will result in a net present value of $72 million.
Analyze and prepare a decision tree.
What is the best alternative in terms of expected monetary value?

Application of economic techniques to the evaluation of design and engineering alternatives. The role of engineering economics is to assess the appropriateness of a given project, estimate its value, and justify it from an engineering standpoint.

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