# A firm that plans to expand its product line must decide whether to build a small or a large facility to produce

QUESTION:

A firm that plans to expand its product line must decide whether to build a small or a large facility to produce the new products. If it builds a small facility and demand is low, the net present value after deducting for building costs will be \$ 400,000. If demand is high, the firm can either maintain the small facility or expand it. The expansion would have a net present value of \$ 450,000, and maintaining the small facility would have a net present value of \$ 50,000.

If a large facility is built and demand is high, the estimated net present value is \$ 800,000. If demand turns out to be low, the net present value will be – \$10,000. The probability that demand will be high is estimated to be .60, and the probability of low demand is estimated to be .40.

a. Analyze using a tree diagram.

b. Compute the EVPI. How could this information be used?

c. Determine the range over which each alternative would be best in terms of the value of P (demand low)?

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