5. The Weston Co. is thinking of building a plant to manufacture a new product recently developed.

by its R&D department. Several alternatives. are available to the firm regarding the size of the plant. The company can construct a large plant, which will cost 25,00,000. Under different demand conditions the cash flows with associated probabilities are expected to be as follows: Large Plant Demand Cash inflow () condition Probability (year 1-10) High 0.50 Medium 0.40 1,25,000 1,00,000 Low 0.10 50,000 The alternative to building a large plant is to build a smaller plant for 2,00,000 now, with an option to build an additional plant after two years if the product achieves sufficient success. The small plant has a capacity to maintain *80,000 in cash flows. Under high or medium demand the plant will be fully utilized. The expected cash flows with associated probabilities are as follows: Small Plant Demand condition Probability High 0.50 Medium 0.40 Low 0.10 Cash inflow () (year 1-2) 80,000 80,000 40,000 After two years, the company can review the situation to expand the smaller plant. If the company experiences a high initial demand for the first two years, a 3,00,000 addition could be built, increasing yearly revenue potential by 260,000. The company estimates the net cash flows with. associated probabilities under different demand conditions as follows High Initial Demand: Additional Plant of 3,00,000 Demand condition High Medium Low Probability 0.60 0.30 0.10 Cash inflow R) Iyear 3-10) 1,40,000 1,10,000 80,000 If only medium demand was achieved in the first two years then a 1,50,000 addition would be considered. The expected cash flows and probabilities are as follows: The alternative to building a large plant is to build a smaller plant for 2,00,000 now, with an option to build an additional plant after two years if the product achieves sufficient success. The small plant has a capacity to maintain *80,000. in cash flows. Under high or medium demand. the plant will be fully utilized. The expected cash flows with associated probabilities are as follows: Small Plant Demand condition Probability High 0.50 Medium 0.40 Low 0.10 Cash inflow (*) (year 1-2) 80,000 80,000 40,000 After two years, the company can review the situation to expand the smaller plant. If the company experiences a high initial demand for the first two years, a 73,00,000 addition could be built, increasing yearly revenue potential by *60,000. The company estimates the net cash flows with associated probabilities under different demand- conditions as follows High Initial Demand: Additional Plant of 3,00,000 Demand condition High Medium Low Probability 0.60 0.30 0.10 Cash inflow (R) (year 3-10) 1,40,000 1,10,000 80,000 If only medium demand was achieved in the first two years then a 1,50,000 addition would be considered. The expected cash flows and probabilities are as follows: Medium Initial Demand: Additional Plant of 1.50.000 Cash inflow (R) Demand condition Probability High 0.60 Medium 0.30 Low 0.10 (year 3-10) 1,10,000 80,000 25,000 The company also considers the possibility of not building any addition regardless of the level of demand. Design a decision tree and solve for the most profitable alternative. Assume a 10 per cent discount rate and that the plants do not have any salvage value.