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Stygian Chemical The management of Stygian Chemical Industries, Ltd. must build a new product with an expected market life of ten years. They can build a small plant or a large one. The decision hinges on what size the market for the product will be: high-volume (that is, high demand) or low-volume (that is, low demand). Possibly demand will be high during the initial two years but, if many initial users find the product unsatisfactory, will fall to a low level thereafter. Or high initial demand might indicate the possibility of a sustained high-volume market. When the demand is low in the introductory period, it will remain low for the next 8 years. If the company builds a large plant, it must live with it whatever the size of market demand. If it builds a small plant, management has the option of expanding the plant in two years in the event that demand is high during the introductory period; while in the event that demand is low during the introductory period, the company will maintain operations in the small plant and make a tidy profit the low volume. on Different viewpoints Management is uncertain about what to do. The company grew rapidly during the 1950's; it kept pace with the chemical industry generally. The new product, if the market turns out to be large, offers the present management a chance to push the company into a new period of profitable growth. The development department, particularly the development project engineer, is pushing to build the large- scale plant to exploit the first major product development the department has produced in some years. The chairman, a principal stockholder, is wary of the possibility of large unneeded plant capacity. He favors a smaller plant commitment, but recognizes that later expansion to meet high-volume demand would require more investment and be less efficient to operate. The chairman also recognizes that unless the company moves promptly to fill the demand, competitors will be tempted to move in with equivalent products. Financial data Payoff 1. A large plant with high demand would yield $1,000,000 annually in cash flow. 2.A large plant with low demand would yield only $100,000 because of high fixed costs and inefficiencies. 3. A small plant with low demand would be economical and would yield an annual cash income of $400,000. 4. A small plant, during an initial period of high demand, would yield $450,000 per year, but this would drop to $300,000 yearly in the long run because of competition. expanded to meet the sustained high demand, it would yield $700,000 5. If the small plant cash flow annually, and so would be less efficient than a large plant built initially 6. If the small plant were expanded but high demand were not sustained, the estimated annual cash were flow would be $50,000. Cost It is estimated further that a large plant would cost $3 million to build, a small plant would cost $1.3 million, and the expansion of the small plant would cost an additional $2.2 million. Probabilities Initially high: 70% Initially low: 30% After initially high, sustained high: 86% After initially high, long-term low: 14% After initially low, subsequently high: 0% After initially low, continuing low: 100 % Question 5 (1 point) If the probability of sustaining high volume after 2 years of initial high volume market is 0.57, the EMV of the overall tree following the solution is A $2,208,675 B $2,450,800 C $2,664,656 D $2,677,483 Question 6 (1 point) If the probability of sustaining high volume after 2 years of initial high volum market is 0.57. The best decision is A Build a large plant B Build a small plant C Build a small plant, and expand if the initial demand is high. D Build a small plant, and do not expand. Question 7 (1 point) Use the original probabilities. If the cost of building a small plant is 1.5 million and the cost of expansion is 1.8 million, the best decision is A Build a large plant B Build a small plant C Build a small plant, and expand if the initial demand is high. D Build a small plant, and do not expand. Question 8 (1 point) Use the original probabilities. If the cost of building a small plant is 1.5 million and the cost of expansion is 1.5million, the best decision is A Build a large plant B Build a small plant C Build a small plant, and expand if the initial demand is high. Build a small plant, and do not expand. D

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