Rohit Dube

ISEN 615 HW 1

37. An analyst predicts that an 80 percent experience curve should be an accurate predictor of
the cost of producing a new product. Suppose that the cost of the first unit is $1,000. What
would the analyst predict is the cost of producing the a. 100th unit? b. 10,000th unit?

Solution:

The Experience Curve is of the form Y(u)=au-b, for the uth unit
where a is the cost to produce the first unit
∴ a=$1000

b measures the rate at which the cost decline as the cumulative number of units produced
increases.

Since experience curves are described as the percentage of cost reduced to produced 2n items
as compared to produce n items.

𝑌(2𝑢) 𝑎(2𝑢)−𝑏
∴ = = 2−𝑏
𝑌(𝑢) 𝑎(𝑢)−𝑏

Since experience curve prediction is 80%

∴ 2−𝑏 =0.8

ln(0.8)
∴ b=− ln(2)

∴ b=0.3219

The experience curve equation is, Y(u)=1000(u)-0.3219

The cost of producing 100th unit is,

∴ Y(100)=1000(100)-0.3219
∴ Y(100)=$227.091

The cost of producing 10000th unit is,

∴ Y(10000)=1000(10000)-0.3219
∴ Y(10000)=$51.57
 Rohit Dube

42. A major oil company is considering the optimal timing for the construction of the new
refineries. From past experience, each doubling of the size of a refinery at a single location
results in an increase in construction costs of about 68 percent. Furthermore, a plant size of
10,000 barrels per day costs
$6 million. Assume that the demand for the oil is increasing at a constant rate of two million
barrels yearly and the discount rate for future costs is 15 percent.
a. Find the values of k and a assuming a relationship of the form f(y)= ky a.
Assume that y is in units of barrels per day.
b. Determine the optimal timing of plant addition and the optimal size of each plant.
c. Suppose that the largest single refinery that can be built with current technology is 15,000
barrels per day. Determine the optimal timing of plant additions and the optimal size of each
plant in this case. (Assume 365 days per year for your calculations.)
Solution:

The oil company follows the law, f(y)=kya

Where, a measures the ratio of the incremental to the average costs of a unit of plant capacity.
k is the constant of proportionality
y is units of barrel per day
Since each doubling of the size of a refinery at a single location results in an increase in
construction costs of about 68 percent

𝑌(2𝑦) 𝑎(2𝑦)𝑎
∴ = = 2𝑎 =1.68
𝑌(𝑦) 𝑎(𝑦)𝑎
𝑎
∴ 2 = 1.68
ln(1.68)
∴ a = ln(2) = 0.748

Use a in the relation,

f(y)=kya
∴ 6 = k(10000)0.748
∴ k = 0.00611
Ans a. The values of k is 0.00611 and a is 0.748

Consider, D be Annual increase in demand, D = 2,000,000 barrels/year

x be Time interval between introduction of successive plants.
r be Annual discount rate, compounded continuously, r=15%
Let C(x), the sum of discounted costs for an infinite horizon given a plant opening at time zero.
We get,

𝑓(𝑥𝐷)
C(x) = 1−𝑒 −𝑟𝑥
 Rohit Dube

𝑟𝑥
This function can be minimized at x, thus, =𝑎
𝑒 𝑟𝑥 −1

𝑢
Let u=rx, the function becomes = 𝑓(𝑢)
𝑒 𝑢 −1

∴ u = 0.6
∴ rx = 0.6
∴ x = 0.6/0.15
∴ x = 4 years

Thus, the optimal timing of plant addition is 4 years.

The optimal value of plant capacity should be,

xD = 4 x 2000000 = 8000000 barrels

Ans b. The optimal timing of plant addition is 4 years and the optimal size of each plant is 8
million barrels.

If 15000 barrels are produced per day due to current technology,

barrels produced per year will be = 15000 x 365 = 5475000 barrels.

∴ xD = 5475000
∴ x = 5475000/2000000=2.7375

The optimal timing of plant addition is 2.7375 years

 Rohit Dube

46. Delon’s Department Store sells several of its own brands of clothes and several well-known
designer brands as well. Delon’s is considering building a plant in Malaysia to produce silk ties.
The plant will cost the firm $5.5 million. The plant will be able to produce the ties for $1.20
each. On the other hand, Delon’s can subcontract to have the ties produced and pay $3.00 each.
How many ties will Delon’s have to sell worldwide to break even on its investment in the new
plant?

Solution:
Let, K be the investment by the company to increase production, K=$5.5 million
c1 be the cost of ties if outsourced
c2 be the cost of ties if produced internally,

The cost for the company to outsource x ties is,

y1=c1x

The cost for the company to produce x ties is,

y2 = K + c2x

For the breakeven quantity the costs of internal production and external outsoutrcing should be
same.

∴ y1 = y2

∴ c1x = K + c2x

𝐾
∴ x = (𝑐
1 −𝑐2 )

5500000
∴ x= (3−1.2)

∴ x = 3055555.56 ties

Thus Delon’s have to sell 3055556 ties to break-even on its investment in the new plant.