Planwell Corporation is considering whether to build a large plant or a small plant for new product, which has an estimated life of 7 years. A small plant requires an investment of $3.4 million and a large plant of $4 million. The following estimates are available for annual income.
Plant Size Demand Annual Income
Large High $900,000
Low $300,000
Small High $600,000
Low $500,000
The probability of high demand in first year is 0.75. If the demand is high in the first year, the probabilities of high and low demands in subsequent years are 0.7 and 0.3 respectively. The probability of low demand in the first year is 0.25. If the demand is low in the first year, the probabilities of high and low demands in subsequent years are 0.2 and 0.8 respectively.
Evaluate the decision alternatives open to the company using decision trees. Which alternative should be followed by the Planwell company and what return can be expected?