A company manufactures stamped steel products. With global competition increasing, the company is looking at options for it to be in a more competitive position. There are three possible market conditions that can develop. There can be high market demand with a probability of 0.4, there can be medium market demand with a probability of 0.5, or there can be a low market demand with a probability of 0.1. It is currently looking at three options. It can automate now (referred to as the Automate Now decision), form an Alliance or delay the decision (referred to as Delayed Decision) for two years. If the company decides to Automate Now, the present value of the returns (this means that the returns are expressed in terms of today’s dollars) are $4.0 million if there is high market demand, $2.6 million if there is medium market demand, and $2 million if there is low market demand. The company could also form an Alliance with one of its suppliers. In this case, the present value of the returns for high, medium, and low market demand are $3 million, $2.8 million and $1 million respectively.
The company can also delay this situation for two years (referred to as Delayed Decision). At that point the company would either automate then or outsource. If it automates then (referred to as Automates Later), the expected return for this decision is $2.5 million. If it outsources Later at that time, the expected return is $3.3 million.
(a) Draw the appropriate decision tree for this company and using an expected value approach, what decision should the company make. Provide your supporting work.
(b) Now, consider only the Automate Now and Delayed Decision options. Let everything else be the same except for the return for the high market demand for the Automate Now option.
What would this return have to be so that the Automate Now and Delayed Decision options are equal?

  • CreatedJuly 26, 2013
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