A Chemical company has to expand its production capacity tocater its growing local and international market .

it has to decide between a large plant and a small plant to bebuilt to address the increasing demand. This is all that must bedecided now. But if the company chooses to build a small plant, andthen finds demand high during the initial period for two years, ithas to expand its plant further. In making decisions, companyexecutives must take account of the probabilities, costs, andreturns which appear likely. On the basis of the data now availableto them and assuming no important changes in the company’ssituation, perform the following;

(i) Develop a decision tree analysis for the Chemical companyfor this potential investment;

(ii) Determine the net expected monetary value EMV (revenue –cost), and decide which alternative should the company

Table Q4-1

Alternatives	Probabilities
Large Plant (cost 3.0 million OMR)	High average demand	0Ù«6
High initial demand (2 yrs), low succeeding demand (8 yrs)	0Ù«1
Low average demand	0Ù«3
Small Plant (cost 1.3 million OMR)	High initial average demand	0Ù«7
Low initial average demand	0Ù«3

Payoff per year (OMR/ year)

1Ù¬179Ù¬296 (for 10 yrs)

1Ù¬000Ù¬000 (first 2 yrs) 100Ù¬000 (succeeding 8 yrs)

100Ù¬000 (for 10 yrs)

537Ù¬028 (first 2 yrs) -

400Ù¬000 (for 10 yrs)

Table Q4-2 : Alternatives, Probabilities & Payoffswhen building a Small plant with High initial averagedemand

(succeeding 8 years)

Alternatives after 2 years of having Small- Plant with high initial average demand	Probabilities
Expand (cost 2.2 million OMR)	High average demand	0Ù«86
Low average demand	0Ù«14
Do not expand	High average demand	0Ù«86
Low average demand	0Ù«14

Payoff per year for succeeding 8 years (OMR/ year)

700Ù¬000

50Ù¬000

300Ù¬000

400Ù¬000