A Pacific Northwest Lumber Company Is Considering the Expansion of One

Essay

A Pacific Northwest lumber company is considering the expansion of one of its mills. The question is whether to do it now, or wait for one year and re?consider. If they expand now, the major factors of importance are the state of the economy and the level of interest rates. The combination of these two factors results in five possible situations. If they do not expand now, only the state of the economy is important, and three conditions characterize the possibilities. The following table summarizes the situation:
$\begin{array}{lll}\text { Expand }& \text { Probabilities } &\text { Revenues }\\\text { very favorable } & 0.2 & \$ 80,000 \\\text { favorable } & 0.2 & \$ 60,000 \\\text { neutral } & 0.1 & \$ 20,000 \\\text { unfavorable } & 0.3 & -\$ 20,000 \\\text { very unfavorable } & 0.2 & -\$ 30,000\\\text { Don't expand }\\\text { expansion } & 0.2 & \$ 50,000 \\\text { steady } & 0.5 & \$ 30,000 \\\text { contraction } & 0.3 & \$ 10,000\end{array}$
a. Using decision tree analysis, what is the expected value (EV) for expanding?
b. Using decision tree analysis, what is the expected value (EV) for not expanding?
c. Based on expected value (EV), what should the company's decision(s) be?