Acp, Inc. (A)
4 Pages Posted: 23 Jun 2009
A division president of a Fortune 50 company must decide whether to initiate an immense capacity expansion. The critical question is whether revenue from the company's major product line will continue to grow rapidly. An opportunity is available to conduct some market research prior to making the decision. This case introduces the steps of decision analysis: decision diagramming, assessing monetary consequences, assigning probabilities, and evaluating expected monetary value to "fold back" the decision tree. The case also develops the ideas of value of information (clairvoyance), control (wizardry), and sensitivity analysis (breakeven probability). (The B case is QA-0431.)
ACP, INC. (A)
John Conmetz wondered if he could justify a capacity expansion that over several years would cost the equivalent of the firm's entire annual capital budget—about five billion dollars. It would not only be an aggressive move; it would also be the largest capital commitment in his two-year tenure as division president of Azure Commercial Products, Inc. (ACP).
Since Conmetz had become president until the time of this case, 1984, revenue growth had been 30% in the company's major product line. If it continued, this growth would more than justify the capacity expansion in his division, which made the chief component of the major product line. Many at corporate headquarters thought growth would continue at this high rate over the 10-year lifetime of the new capital equipment. On the other hand, growth of 5% was more typical of the last 30 years. At the normal 5% growth rate, existing capacity and the use of overtime, which could add 20% capacity, would handle demand for several years.
The question on Conmetz's mind was which scenario of growth would apply through the life of a new plant. It would take six years to bring the plant on-line. The immediate consideration was whether to take the first step to get environmental approval for the new plant, a process that would take one-and-a-half years. Another two years would be needed to build the facility—bricks and mortar—and to add the fittings for the manufacturing equipment. Installing the manufacturing equipment and constructing the complete assembly operation would take an additional two-and-a-half years.
Some financial calculations had been done for scenarios in which the additional capacity was added or not added and for high and normal growth in demand over the life of the new equipment in the capacity expansion. The monetary values accounted for all relevant cash flows, including all costs and revenues over the 10-year life of the plant and a terminal value of the plant. They were stated in terms of the equivalent time-discounted present values at the time of plant start-up. These values are shown in Table 1.
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Keywords: decision analysis, marketing research, probability, risk management, sensitivity analysis, uncertainty
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Acp, Inc. (A)
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