A Chemical Company Is Trying to Decide Whether to Build

Essay

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.
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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 become stagnate. The returns are estimated to be $5 million if it is robust, $3 million if it is stable, and $1 million if it is stagnate.
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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 of favorable outcome for expansion and a 40% unfavorable chance. 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.
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Develop a decision tree for this problem and determine the optimal decision strategy.