Question 3

The sales and finance team of a car company is evaluating a new proposed luxury model of its brand that will require an investment of $1Billion in a new machine for car interior decoration. Demand for the companys car is expected to begin at 100,000 units in year 1, with 10% annual growth thereafter. Production cost will be $35,000 per unit in the first year, and increase by a rate of either 3% or 5% per year as a result of wage increase. Selling price will start at $37,000 and increase by 4% of the production cost. The model will be phased out at the end of year 10. In addition, 0.3%, 2% and 1.5% of before tax profit per year will be spent on social corporate responsibility, commercial (including promotions) and recalls respectively. Assume taxes will be 30% of yearly profit and that inflation will remain at 0% per year throughout the 10 year of production. Also assume interest rate is expected to be 3% per year in the first 5 years and 5% in the last 5 years.

a. Based on present worth analysis, is the proposed investment profitable if production cost increases by a rate of 3% per year as a result of wage increase? Justify your answer. (15 marks)

b. Based on present worth analysis, is the proposed investment profitable if production cost increases by a rate of 5% per year as a result of wage increase? Justify your answer. (15 marks)

Question 4

The CEO of Asempa farms limited is considering whether to plant this years yam with a fertilizer or go organic (i.e. without fertilizer). In case of using a fertilizer, 10kg of either the Platinum or Standard type fertilizer would be needed at the start of the planting year. The Platinum type is GH1000 per kilogram and could lead to a high yield of 30 tons or a moderate yield of 20 tons of yam at the end of the year. The Standard type is GH800 per kilogram and could also lead to a high yield of 15 tons or a moderate yield of 10 tons of yam at the end of the year. The Standard has fewer chemicals and would lead to tastier yam that sells for a higher price than that of Platinum. There is a probability of 0.7 that high yield would be recorded at the end of the year.

Market price for yam is uncertain and depends on the type as well as the volume of yam on the market. Generally, a year of high yield results in higher volume whiles a year of moderate yield leads to moderate volume of yam on the market. Even then, there is 60-40 chance that yam from the Platinum fertilizer could sell for GH2000 or GH2400 per ton in times of high yield, and GH3000 or GH3500 per ton in times of moderate yield. The Standard fertilizer yam has a 40- 60 chance of selling for GH4000 or GH5000 per ton in times of high yield, and GH5500 or GH6000 in times of moderate yield.

Organic yam would take 2 years to harvest and would require the supply of manure that can be borrowed from a local shop at a total cost of GH8,500 at the end of year 2. This could lead to a high yield of 8 tons or a moderate yield of 6 tons at the end of year 2. Prices for organic yam are quite high and will sell for GH9,000 per ton in a high yield season and GH11,000 in moderate yield season. Assume interest rate of 10% per year and answer the following questions.

a. Draw a decision tree for the problem faced by the CEO indicating the probabilities of occurrence and monetary values of events.

b. Advice the CEO of Asempa farms on which decision to take if he wants to make his decision based on expected monetary value technique. Show your calculations.

c. Will your advice change if the total cost of manure at the end of year 2 is GH6000? Show your calculations.

d. What would be Asempa farms payoff if there happens to be a moderate yield, and price of yam is GH6000 per ton?

e. If the CEO of Asempa farms is risk averse, which decision do you think the CEO should opt for? Explain.