The managers of a chemical company have to decide whether to extend their existing plant or replace it with completely new equipment.

The managers of a chemical company have to decide whether to

extend their existing plant or replace it with completely new equipment.

A simulation of the two alternatives gives the following

probability distributions of net present value:

210 Applying simulation to decision problems

Probabilities

NPV ($m)

Extend existing

plant

Replace with new

equipment

−3 to under −2 0.05 0.00

−2 to under −1 0.05 0.05

−1 to under 0 0.15 0.15

0 to under 1 0.29 0.26

1 to under 2 0.22 0.21

2 to under 3 0.14 0.18

3 to under 4 0.10 0.10

4 to under 5 0.00 0.05

(a) Compare the two distributions, and stating any necessary

assumptions, determine the option that the management should

choose.

(b) After the above simulations have been carried out a third possible

course of action becomes available. This would involve the

movement of some of the company's operations to a new site.

A simulation of this option generated the following probability

distribution. Is this option worth considering?

NPV ($m) Probability

−2 to under −1 0.05

−1 to under 0 0.05

0 to under 1 0.40

1 to under 2 0.40

2 to under 3 0.04

3 to under 4 0.03

4 to under 5 0.03