Exercise 3 (Decision Tree) – Creating the Tree

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To create the tree and determine that a 25,000 car production capacity will, under the conditions shown, provide the highest five-year profit, 2003-2007:
Recall: Profit = Revenue – Costs
Gross Profit per year = #RX 330’s sold that year * ($37000 – $28000)

(Ie, profit/car sold = $9000)

#RX 330’s sold per year = lesser of production capacity or weighted mean demand
Weighted mean demand per year = Probability low demand * #sales if low demand + Probability moderate demand * #sales if moderate demand + Probability high demand * #sales if high demand

(ie, for 2007: .25 * 12000 + .50 * 19000 + .25 * 30000 = 20000 (cars)
Net Profit = Gross Profit – Factory Costs (ie, Factory Initial Cost + Maintenance Expense), for each capacity, over five years.
Factory Initial Cost = $50M + (Capacity – 10000) / 5000 * $15M

Maintenance Expense = Capacity/5000 * $5M * 5 years

Exercise 3 (Decision Tree) – Creating the Tree

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One way to do the calculations is:

1. Start with a factory production capacity of 10K
2. Calculate the profit (or loss) for 2003 for the weighted mean demand for 2003
3. Repeat for each year… 2004, 2005…. and add to obtain total profit over five years for that capacity
4. Repeat the whole process for higher initial capacities … 15K, 20K….

Pick the capacity that provides the highest profit over the specified five years, 2003-2007, which is 25,000 cars = $554,000,000 estimated profit.
Then write up the weaknesses or limitations in this analysis.

Here again is the created tree: (To remind, numerous computer software programs exist to assist with tree calculation and display)