IB Business Management 1.

7 Organizational Planning Tools

MORE PEQ: Decision Tree Past Exam Practice

1. Primature Inc.

Following a 13% increase in orders over the last six months, Primature Inc is considering the
expansion of its production facilities. It is presently producing at 98% of its production capacity. The
production manager is examining two expansion options:

Option 1 – The construction of an extra production line in the present factory building at a cost of
1.5m. This will increase capacity by 16%.

Option 2 – The construction of an additional factory unit at a cost of $3.5m. The new building could
be designed to allow for cell production and just in time (JIT) management. This would cut costs and
provide additional future production flexibility and human resource advantages. Capacity could be
increased by a maximum of 40%.

The recent increase in orders is as a result of improved economic conditions. However, the finance
director is not convinced it is wise to invest in either option before it is clear that the increase in
economic growth will be maintained. He believes unit price and revenues can be increased at
current output, provided economic growth remains constant or improves. Economists differ on their
forecasts for the next five years. 40% of those asked believe that the economy will strengthen over
the next five years. 30% believe that average growth over that period will remain constant, whilst
30% believe there will be a decline in economic growth. The production manager estimates the
following profit/loss outcomes for each of these predictions:

Option 1 Option 2 Option 3

(new line) (new factory) (no expansion,
$m $m increase unit price)
$m
Economy strengthens 6 9 4
Constant economic growth 3 4 3
Declining economic growth 1 2 –1

a. Construct a fully labelled decision tree showing Primature Inc’s options with the
financial costs and outcomes for each option. Show full working. [9]

b. Using your decision tree, decide which option Primature Inc should select on purely
financial grounds. [1]

c. Explain two advantages and two disadvantages of using a decision tree. [4].

Check: Extra line 2.1 New Factory 1.9 Do Nothing 2.2

D. Kelly 1 Decision Trees

IB Business Management 1.7 Organizational Planning Tools

2. Protect Ltd.
Protect Ltd is an Australian leisure clothing company. It imports materials from Asia to produce high
quality clothing used by walkers and joggers. It has a large share of the domestic market, but in recent
years also exported to Europe. These exports now represent 60 % of all sales revenues.

The research and development department has invented a new lightweight, breathable waterproof
fabric. Initial primary and secondary market research has shown very positive results from existing
customers and identified potential applications to a range of sports markets. To manufacture new
garments using this fabric, Protect Ltd will need new manufacturing equipment. The research and
development department believes that it can improve the fabric further to provide the strength
necessary for contact sports such as rugby and American football.

The board of directors recently identified three potential strategic options:

1. As the sports market is highly competitive, sell the patent for the new fabric to a leading
sportswear manufacturer for $10 million.

2. Purchase machinery at a cost of $2 million to manufacture the new fabric as outdoor clothing.
The estimated success of this option is 80 % with returns of $20 million. However, the failure of
the product in the marketplace would result in a loss of $5 million.

3. Conduct further research and development into improving the fabric for sports use. This
would cost $2 million. Failure to produce a suitable fabric would result in a loss of $5 million.
However, it is believed that there is a 60 % chance of success. If a suitable fabric is produced
then the firm would have another choice. They could either sell the patent for the improved
fabric for $25 million, or choose to manufacture it themselves at a cost of $2 million. If they
choose to manufacture, the estimated chance of a successful market launch is 50 % with
estimated returns of $72 million. However, if the market launch proves a failure, they would
make a loss of $8 million.

The board of directors are concerned about the economic conditions in Europe, with the expectation of
increases in inflation and interest rates. Asian currency markets are also volatile with Asian exchange
rates expected to rise.

(a) Define the term private limited company. [2]

(b) Prepare a decision tree to show the three options available to Protect Ltd,
the expected values of each, and identify the most profitable option. [8]

(c) With reference to the external environment and the decision tree prepared
in (b), recommend an appropriate course of action for Protect Ltd. [10]

Check: Sell patent 10 Manufacture outdoor clothes 13 Research/Make sports clothes 14

D. Kelly 2 Decision Trees