Question: In early January, Etta Laboratories received an order for 10,000 ounces of its new product, Calbonite, an ingredient used to manufacture a new variety of drugs. This way by far the largest order ever received for Caolbonite---total production in the previous year had been only 1,200 ounces. The order called for 5,000 ounces to be delivered in June and the remainder in November.

The process now used to synthesize Calbonite was a long one, involving processing small batches of raw material through several stages. The company would have to invest $50,000 in new equipment to bring the production capacity up to the 1,000 ounces per month level needed to meet the order. It would take the month of January to order and set up the equipment. The variable manufacturing cost per ounce this process was known to be $15.

One of the research chemists at Etta had just discovered a new process for synthesizing Calbonite. If the process could be made to work on a large scale, it would greatly simplify the production process, with potentially great savings in cost. Ordinarily, a discovery of this sort would be tested thoroughly in the laboratory and in a small pilot plant to be sure it worked and to estimate production costs. This would take about a year. However, because of the potential savings, management wondered if it should shorten this test period. The engineering department suggested a crash testing program lasting vie months. At the end of this period, it would be known whether or not the process would work, and estimated production costs would be determined. This test would cost $20,000 more than the more extended test.

It was estimated that there was a 0.9 chance the new process would work. Further, given that the new process worked, the chances were 4 out of 10 that the production cost would be $2 per ounce, 4 out of 10 that it would be $10 per ounce, and 2 out of 10 that it would be $18 per ounce.

If a decision was made at this stage to use the new process, the month of June would be used to set up the new manufacturing process. This, if this testing program were utilized, the company would have to set up and run the first 5,000 ounces using the old process.

Also, note the only the incremental costs associated with crash testing the program need to be charged against the alternative. Since this company would test and buy the equipment for the new process if the tests were successful independent of this decision, the costs associated with these activates need not be considered in this decision.

1. Draw a decision tree for this problem
2. What decisions should be made? What is the expected cost of filling the order?

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