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Decision Trees Questions

The board of ATR is considering 3 options for its Victory Van factory: 1) total closure at a cost of $15 million, 2) no changes and hope the economy improves, or 3) redevelop the factory with new automated machinery at a cost of $180 million. Redevelopment would receive a $180 million subsidy if the regional government is re-elected. The financial director provided profit/loss information under different economic scenarios with and without the subsidy. A decision tree was constructed to calculate the expected values of each option to help the board's decision.

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Decision Trees Questions

The board of ATR is considering 3 options for its Victory Van factory: 1) total closure at a cost of $15 million, 2) no changes and hope the economy improves, or 3) redevelop the factory with new automated machinery at a cost of $180 million. Redevelopment would receive a $180 million subsidy if the regional government is re-elected. The financial director provided profit/loss information under different economic scenarios with and without the subsidy. A decision tree was constructed to calculate the expected values of each option to help the board's decision.

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© © All Rights Reserved
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February 16, 2011 [DECISION TREES TASK]

1. ATR, an American multinational vehicle manufacturer, acquired a medium-sized European


company, Victory Vans, in 1997. An economic downturn in both 1998 and 1999 led to falling
demand and unexpected losses. The board of ATR are meeting to consider the following three
options identified by the Managing Director.

1 Total closure of the Victory Van factory. This would cost ATR $15 million in employee
compensation and administrative charges.

2 Keep the Victory Van factory operating as it is, knowing that it would only become
profitable if the economy improves. The Managing Director estimated that the chance of
the economy improving was only 20%. He said that there was a 30% chance of the
economy remaining constant and a 50% chance of it continuing to worsen.

3 Redevelop the site and install new automated machinery at a cost of $180 million to
produce a new model of van.

The cost of redevelopment would be offset by a subsidy negotiated with the regional
government who were keen to see Victory Vans remain in the region. However, this subsidy
depended upon the government being re-elected in an upcoming election. Opinion polls
suggested a 70% chance of this happening. If the opposition party was elected they had
promised to cancel the subsidy.

The Financial Director presented the following profit and loss information:

Economic climate Improve Constant Worsen


$m $m $m
No development 120 0 –80
Redevelopment
with subsidy 480 260 180
Redevelopment
with no subsidy 300 80 0

2. Construct a decision tree to illustrate all of ATR’s options and add all the data provided and
calculate expected values.
(Total 9 marks)

4. Which of the options would the board of directors select on a purely financial basis?
(Total 1 mark)

6. Assess the advantages and disadvantages of using a decision tree to assist in decision making.
(Total 4 marks)

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