# ENGINEERIN 3302 Develop the matrix of investment alternatives

Problem 1

Project 1, 2, 3 with a lives of 5 years are being considered

with cash flow estimated to be as follows

Project 1(k$)

Project 2(k$)

Project 3 (k$)

Investment

65,000

58,000

93,000

Annual Revenue

23,000

19,500

29,000

Annual Cost

5,000

4,500

6,000

Salvage Value

0

10,000

15,000

Suppose that proposal 1 and 3 are mutually exclusive,

project 2 is contingent on project 1. The budget limit is $130,000.

(a)

Develop the matrix of investment alternatives,

indicate which one is not feasible, and give reason for the infeasibility (5

points)

(b)

Develop the composite cash flows for the

feasible alternatives (5 points)

(c)

Suppose the MARR is 10%, determine the best

alternative using Present Worth analysis. (5 points)

Problem 2

You have to solve the following problem for the CEO of Super

Superconductors, Inc. (SSC). She needs the answer in writing by 10:00 PM

tonight. SSC makes a superconducting wire that operates at the temperature of

liquid nitrogen; it sells about 10,000 kilometers of this product per year.

There are rumors, however, that a competing company (Superconductors R US

(SRU)) is producing a wire that superconducts at the temperature of liquid

oxygen, which is higher – (90 °K vice 77 °K), thus it is easier to use. SSC has a project proposed

for R&D for a superconductor that works at liquid oxygen temperatures, but

it hasn’t produced a material that is profitable to produce. The CEO thinks

that there is a 40% chance that SRU has produced the better superconductor. If

SRU has managed to develop the better superconductor, and SSC fails to produce

an equivalent product, sales of the existing product will decrease by 50%.

Otherwise, sales stay the same.

SSC’s CEO can authorize $50 million to do the R&D

project. The R&D project can produce an oxygen temperature superconductor,

but it isn’t clear if the result will be an inexpensive product or an expensive

one – there is a 50 – 50 chance of either outcome. If the R&D produces an

inexpensive superconducting wire, SSC will switch from making the current wire

to the new, cheap oxygen temperature wire. If SSC makes the cheap wire and SRU has an oxygen-level

superconducting wire also, then SSC’s sales of the new product will be 8,000

km/yr. If SSC makes the cheap wire and SRU doesn’t

have an oxygen-level superconducting wire also, then SSC’s sales of the new

product will be 15,000 km/yr.

If the R&D can only produce an expensive version, SSC’s

CEO will have to decide to make the old product or the new one. If they

continue to make the old one, sales will drop 50% if SRU does produce a new

oxygen temperature superconductor and stay the same if it doesn’t. However, if

SSC makes the new superconductor instead of the old one, sales will be 3,000

km/yr. if SRU does produce a new oxygen temperature superconductor and 7,500

km/yr. if it doesn’t.

Assume that SSC makes $10 /meter (1 km = 1,000 meters) if it

sells the old superconducting wire,

$18/meter for the inexpensive oxygen temperature superconducting wire,

and $7/meter for the expensive oxygen temperature superconducting wire (these

are net profits). Assume that the decision will be made based on the first

year’s sales (with either the old or new superconducting wire, depending upon

the decision).

Should SSC’s CEO spend the $50 million on R&D? If she

does, should she sell the newer oxygen-level superconducting wire that comes

out of R&D?

(1)

Draw an influence diagram showing this problem.

(10)

(2)

Draw a decision tree showing this problem. (10)

(3)

Solve either one by hand for the answer. (10)

Problem 3

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.

(a)

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. (10 points)

(b)

Suppose the MARR of Fort Motor is 10%, solve the

decision problem for Fort Motor’s manager using EMV based on present worth. (10 points)

(c)

Draw the risk file and the cumulative risk

profile for the selected strategy. What conclusion can you draw from looking at

the profiles? (10points)

Problem4

As a manager of a small business, you are considering to

introduce a new product. The production requires a new machine. You figure out

that you could buy it for $190,000, but the price could be in between $180,000

and $200,000. Because of the budget limitation you can only pay 60% of the

machine price with your own saving. You

will borrow the other 40% with an interest rate around 9% per year (but subject

to change in between 8.5% and 10%).

The demand of this product is predicted to be 15,000 per

year and but could be in between 14800 and 15500. The unit price could be in

between $2 and $3, and now you believe that $2.5 is a reasonable price right

now. The raw material cost is estimated to be $0.9 but could be in between $0.5

and $1.2. The operation cost of the equipment is around $0.2 for one product

but could be in between $0.1 and $0.25.

The maintenance cost for this equipment is estimated to be $2000 per

year but could be in between $1500 and $2300.

Suppose you could always invest your cash in the money

market that give a return at 8% per year for sure.

Please do following analysis:

a)

Construct the Influence Diagram for this

decision problem and identify the inputs and mathematic models that relate

these inputs (decision variables) to the decision problem. (5)

b)

Construct the Tornado Diagram (5)

c)

Based on Tornado Diagram, identify two most

sensitive variables, and do two-way sensitivity analysis based on these two

variables. Illustrate your result in two-way sensitivity graph (10)

d)

Can you decide whether to invest after these

analyses? If not, what to do next? (5)

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