(Solution Download) The president of ChemTech is trying to decide whether to


The president of ChemTech is trying to decide whether to start a new product line or purchase a small company. It is not financially possible to do both. To make the product for a 3-year period will require an initial investment of $250,000. The expected annual cash flows with probabilities in parentheses are: $75,000 (0.5), $90,000 (0.4), and $150,000 (0.1). To purchase the small company will cost $450,000 now. Market surveys indicate a 55% chance of increased sales for the company and a 45% chance of severe decreases with an annual cash flow of $25,000. If decreases are experienced in the first year, the company will be sold immediately (during year 1) at a price of $200,000. Increased sales could be $100,000 the first 2 years. If this occurs, a decision to expand after 2 years at an additional investment of $100,000 will be considered. This expansion could generate cash flows with indicated probabilities as follows: $120,000 (0.3), $140,000 (0.3), and $175,000 (0.4). If expansion is not chosen, the current size will be maintained with anticipated sales to continue. Assume there are no salvage values on any investments. Use the description given and a 15% per year return to do the following.
(a) Construct a decision tree with all values and probabilities shown.
(b) Determine the expected PW values at the "expansion/no expansion" decision node after 2 years, provided sales are up.
(c) Determine what decision should be made now to offer the greatest return possible for ChemTech.
(d) Explain in words what would happen to the expected values at each decision node if the planning horizon were extended beyond 3 years and all cash flow values continued as forecasted in the description.

 







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