Question

HW7-Module A: Decision-Making Tools-Homework A firm must decide whether to construct a small, medium, or large stamping plant. A consultant's report indicates a 0.40 probability that demand will be low and a 0.60 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 $40 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $52 million o 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 $12 million; if demand turns out to be high, the firm could do nothing and realize a net present value of $45 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 −$30 million, whereas high demand will result in a net present value of $75 million.

Draw a decision tree for this problem.

Answer 1

A decision tree can be constructed to visualize the firm's decision-making process for constructing a stamping plant based on the different scenarios and their associated net present values.

Step-by-step explanation:

A decision tree can be constructed to visualize the firm's decision-making process for constructing a stamping plant based on the different scenarios and their associated net present values.

The decision tree would have three branches representing the firm's options: building a small facility, building a medium-sized facility, or building a large facility. Each branch would then split into two further branches representing the two possible demand scenarios: low demand and high demand. Finally, the corresponding net present values for each scenario would be assigned to the terminal nodes of the decision tree.

This decision tree would help the firm evaluate the expected returns for each option and make an informed decision based on the probabilities of different demand scenarios.