Exhibit 11-2 Suppose We Want to Choose Capacity for a Plant That

Essay

Exhibit 11-2
Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information:
∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event.
∙A unit of capacity costs $16 to build in year 1.
∙The number of units produced will equal the demand, up to capacity limits.
∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost).
∙The maintenance cost per unit of capacity is $0.40 (fixed cost).
∙The discount rate is 10%.
-[Part 3] Refer to Exhibit 11-2.Briefly explain why designing the plant for the expected capacity is clearly not the optimal solution.