A firm must decide whether to construct a small, medium or large stamping plant. A consultant's report indicates a 0.65 probability that demand will be low and a 0.35 probability that demand will be high.
If the firm builds a small facility and demands turn out to be low, the net present value will be $25 million. If demand turns out to be high, the firm can either subcontract and realize the net present value of $26 million or expand greatly for a net present value of $29 million. The firm could build a medium size facility as a hedge: If demand turns out to be low, its net present value is estimated at $18 million. If demand turns out to be high, the firm could do nothing and realize a net present value of $27 million
If the firm builds a large facility and demand is low, the net present value will be -$12million, whereas high demand will result in a net present value of $32 million
1. Draw a decision tree diagram for this problem
2. Analyze and solve the Tree Diagram to evaluate the alternatives. Select the best alternative