9. A firm must decide whether to construct a small, medium, or large stamping plant
9. A firm must decide whether to construct a small, medium, or large
stamping plant. A consultant’s report indicates a .20 probability that demand will be low and an .80 probability that demand will be high.
If the firm builds a small facility and demand turns out to be low, the net present value will be $42 million. If demand turns out 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-sized 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.
a. Analyze this problem using a decision tree.
b. What is the maximin alternative?
c. Compute the EVPI and interpret it.
d. Perform sensitivity analysis on P(high).
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