The manager of Fort Motors is considering developing one of two proposed new car models, A and B. For Model A, it is estimated that a one-time investment of $1000,000 will be required by product design at the beginning of the first year. For model B, a one-time investment of $500,000 to product design is needed at the beginning of the first year. The introduction of either model to the market depends on the result of market survey that will be conducted after the concept car is designed. The period required from design to beginning production of either car model is expected to be 2 years. If the model is not introduced, the investment to the product design can not be recovered. Based on the initial analysis, the probability for model A not introduced to marker is estimated to be 0.4. The probability for model B not introduced to marker is estimated to be 0.3.
If the car model A is introduced to market, it will need a one-time investment of $3000,000 to modify the existing production line at the end of year 2. The market demand for this car model can either be High, Medium, or Low. The probability is estimated to be P (high)=0.3, P (medium)=0.4 P (Low)=0.3. Depending on the market demand the net annual revenue is estimated to be $2500,000 for high demand, $2,000,000 for medium demand, and $1,500,000 for low demand. The production of Model A will be continued for 5 years.
If the car model B is introduced to market, it will need a one-time investment of $500,000 to modify the existing production line at the end of year 2. The market demand for this car model can also be either High, Medium, or Low, with P (high)=0.5, P(medium)=0.3, P(Low)=0.2. Depending on the market demand, the net annual revenue is estimated to be $1,000,000 for high demand, $600,000 for medium demand, and $400,000 for low demand. The production of Model B will be continued for 5 years.
Suppose Fort Motor’s design team can only afford to design one car model, structure this problem with a decision tree, draw the cash flow diagram for each decision path, find the present worth for each decision path.
Suppose the MARR of Fort Motor is 10%, solve the decision problem for Fort Motor’s manager using EMV based on present worth.
Draw the risk file and the cumulative risk profile for the selected strategy. What conclusion can you draw from looking at the profiles?
