A chemical company is trying to decide whether to build a pilot plant now for a new chemical process or to build the full plant now. If they build a pilot plant now, they could expand it later to a full plant or license the plant to another company. It would cost them $2 million to build the pilot plant and another $2 million later to expand it. If they build the full plant now it would cost $3.5 million to construct. The returns they expect to get from the full production plant depend upon the market. They estimate there is a 60% chance the market will be robust, a 30% chance it will remain stable, and a 10% chance it will decline. The returns are estimated to be $5 million if it is robust, $3 million if it is stable, and $1 million if it declines.

Before they expand the pilot plant, they plan to conduct a comprehensive study. Based on past experience, they expect the study to report a 60% chance for a favorable outcome regarding expansion and a 40% for a unfavorable outcome. In either case, they will have to decide whether to expand to a full plant or license the pilot plant. If the report is favorable and they license it, they expect to get $3 million. However, if the report is unfavorable and they license it, they will only get $1 million.

A. Develop a decision tree for this problem. 

B. What is the optimal decision strategy and the expected value? 

C. What would the company decide if it had to pay $150,000 for the comprehensive study? 

D. Calculate the chance value of the report being unfavorable (i.e., change from 40%) so that the company would make a decision different than the one determined in 7B? 

Answer rating: 100% (QA)

A Decision tree is as follows The Expected Values are w... View the full answer