Dan Reid, chief engineer at New Hampshire Chemical, Inc., has to decide whether
ID: 442114 • Letter: D
Question
Dan Reid, chief engineer at New Hampshire Chemical, Inc., has to decide whether to build a new state-of-art processing facility. If the new facility works, the company could realize a profit of $200,000. If it fails, New Hampshire Chemical could lose $150,000. At this time, Reid estimates a 60% chance that the new process will fail.
The other option is to build a pilot plant and then decide whether to build a complete facility. The pilot plant would cost $10,000 to build. Reid estimates a fifty-fifty chance that the pilot plant will work. If the pilot plant works, there is a 90% probability that the complete plant, if it is built, will also work. If the pilot plant does not work, there is only a 20% chance that the complete project (if it is constructed) will work. Reid faces a dilemma. Should he build the plant? Should he build the pilot project and then make a decision? Help Reid by analyzing this problem
Explanation / Answer
If Project works, profit = $200,000
if fails, loss = $150,000
Profit = $200,000*40%+(-$150,000)*60%
=80000-90,000 = $(10,000)
for pilot Project:
cost of the pilot project = $10000
if it works, then
profit = 200,000*50%*90%= 90,0000-10,000 = 80,000
if it not works
200,000*20%*50% = 20,000-10,000 = 10,000
it is better to build a pilot project to make the decision as the profit in the both cases are positive.
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