engineering and production capacity

The Arlington Ballroom II Company is a toy manufacturing company interested in expanding its product line to the development and manufacturing of simple robots for to help children with learning. In order to obtain the engineering and production capacity to enter this market the company will either have to build a new facility or expand and upgrade its current facilities. The development team has narrowed the alternatives to two approaches to obtain the required capacity: (1) a new facility, at a cost of $30 Million, or (2) expansion/upgrade of current facilities, at a cost of $15 Million. Both approaches would require the same amount of time for implementation.

A rigorous study conducted by a team of economic and financial experts indicates that over the required payback period, demand for the product will either be high or moderate. Since high demand is considered to be somewhat less likely than moderate demand, the probability of high demand has been estimated at 0.35. If demand is high, a new facility would result in an additional $60 Million in revenue, but expansion/upgrade only an additional $30 Million, due to lower maximum production capability. On the other hand if demand is moderate, the comparable figures would be $25 Million for a new facility and $10 Million for expansion/upgrade. (All costs and profit values are figured on a present value, using an appropriate rate of return)

If Cardinal wishes to maximize its expected monetary value, should it obtain a new facility or expand? Provide a decision tree or some other means of representing your calculation. What other factors (besides EMV) might play into Cardinal’s decision whether to modernize or expand?

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