Section 3 – DECISION ANALYSIS

Question 4

A company is considering its strategy to further expand its activity into a foreign market it recently accessed. The foreign government has announced that a new industrial site will be offered for sale on a competitive tender basis, the site going to the company making the highest bid. The multinational has a good experience with this type of auctions, and – based on its assessment – it decides that if it is to bid for the site, it will place a bid of £750 million. In the past, 70 percent of the company’s bids for such type of project have been successful.

The marketing department indicated that expansion of the multinational’s foreign market activity can be expected to generate revenue of around £1,500 million if demand turns out to be high, versus only £500 million if demand turns out to be low. Data scientists have indicated that the probability of high demand is 0.60.

If the company is successful in its bid, it will also have to decide whether to construct a new plant for the site or to move an existing plant which has proven to be inefficient. Building the new plant from scratch costs £250 million, while moving the existing plant costs around £100 million. However, in case demand proves to be high, the new plant, equipped with state-of-the-art technology, would boost production by £150 million.

The same multinational company is also under pressure to refurbish some other of its existing plants. The £750 million could be used for this purpose instead. If the money is used for refurbishment, there is a 50 percent chance of increasing efficiency to generate a return on the £750 million of 5 percent, and a 50 percent chance of generating a return of 10 percent. If the decision to refurbish takes place after the bid has been made and failed, £500 million will be invested for refurbishment.

A) Construct a decision tree for this problem and suggest a suitable decision for management.

B) What is the maximum bid the company would consider? What is the value of perfect information about foreign market demand?

C) Can you explain why and howyour answer in part A would change, if management had different attitude to risk (pessimistic vs optimistic)?