Question: (22)

A company is introducing a new product. It has the option of setting up a commercial plant now or setting up a pilot plant at present and then setting up a commercial plant later depending on how the product performs. It has been estimated that the present cost of setting up the pilot plant will be $200000 and the cost of setting up a commercial plant will be $2100000. However, when the commercial plant is set up three months later, after observing the performance of the product, it will cost $2500000.

It has also been estimated that that the probability of the product giving a high yield during the pilot stage is 0,9 and the probability of a low yield is 0.1. If the product is introduced commercially, without going through a pilot plant stage, it is expected that it will give a high yield of profits with a probability of 0.7. If the pilot plant does show a high yield then the probability that the commercial plant will also give a high yield is 0.85. However, if the pilot plant gives a low yield, the probability that the commercial plant will also give a high yield is only 0.1. The estimated profits from high yield at the commercial stage are $12250000 and if the yield is low, the company will suffer a loss of $1525000.

5 .1 Draw a decision tree depicting the above problem. (8)

5 .2 What decision should the company take? Show how you arrived at the answer. (14)

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