Hawthorne Plastics

Prepared by: Eden Frost

Executive Summary

Overview
Hawthorne Plastics is a company that specializes in the fabrication of plastic parts. Currently,
the majority of its business reliant on subcontracting for toy manufacturers, but the company is
considering a shift towards developing proprietary product lines. As part of this strategic pivot,
the company’s leadership has signed o on a contract to produce polypropylene plastic
strapping, a product with growing demand, on behalf of the David F. Punes Strapping Co.
However, before production can begin, the company’s production engineer Ralph Nelson, must
make a key decision regarding the production process that will be used to produce the plastic
strapping.

Key Challenge
The primary challenge involves determining the most pro table production process for
polypropylene strapping under conditions of material quality uncertainty. The company must
decide between three di erent production processes, each with varying costs, setup
requirements, and quality outcomes. The decision is complicated by the fact that the quality of
the nished product relies on both the quality of the raw material inputs, which have a 50-50
chance of being either high quality or low quality (Long vs. Short chain), and the production
process selected. Therefore, Nelson needs to consider the trade-o s involved with each
process and select the process that o ers the best chance of the highest pro ts.

Key Decision Variables

The key decision variables Nelson must consider in his decision include the production
processes, the quality of raw materials, the market prices for high and standard quality
strapping, and the option to pay to test the raw material prior to beginning production.

Production Processes
Process 1 is the lowest cost option with a variable cost of 13c per pound of strapping plus a
$200 per batch set up cost, but is only capable of producing average quality strapping,
regardless of the quality of raw material.

Process 2 is slightly more expensive with a variable cost of 15 cents per pound of strapping
plus a $500 set-up cost ($700-$200 sunk experimentation cost), but is capable of producing
high quality strapping if the raw material used in production is of the long chain variety, and if
the extruding machine’s pressure remains above 150 PSI. Given historical pressure data from
past production runs, Nelson knows there is about a 60% chance of maintaining high pressure
throughout the extrusion process.

Process 3 is the most expensive but is guaranteed to produce high-quality strapping as long
as the raw material is of the long-chain variety. If the raw material is of the short-chain variety,
process 3 will result in an average quality nished product. With a variable cost of 17 cents per
pound of strapping and a set-up cost of $1000 ($1200-$200 sunk experimentation cost),
process 3 is the riskiest to pursue without information regarding the quality of the raw material.

Raw Materials and Market Price

The key variables in uencing the production process decision are the quality of raw material
and the market price of high vs. average quality strapping. The quality of the raw material input
is unknown, but has a 50% chance of being either of the Long or Short chain variety.
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 The Long chain variety can be processed into high quality nished strapping (using process 2
or 3), which sells for 60 cents per pound. The Short chain variety, no matter the production
process, can only be processed into average quality strapping, which sells for 50 cents per
pound.

Testing Option
Nelson is also considering the option of paying to test the raw material, which would provide
some information regarding the quality of the material. The test costs $200 to perform and has
varying rates of accuracy. For example, on batches known to be of long chain material, the test
was accurate 96% of the time. However, for batches known to be of short chain material, the
test incorrectly identi ed the material as long chain 24% of the time. Therefore, Nelson needs
to consider whether the information provided by the test is worth the $200 it costs to perform.

Analysis
The analysis of Nelson’s production decision requires a cost-bene t assessment of each
production process's costs against potential revenues under di erent quality outcomes. This
involves estimating the likelihood of obtaining high or average quality material and estimating
the likelihood of maintaining high or low extrusion pressure during Process 2. These
probabilities are then integrated into the expected value calculations for each process. Given
the various dependencies involved in determining the production outcome, a decision tree1 is
used to map out each potential decision pathway, incorporating probabilities, costs, and
revenues to visualize the decision-making process. Finally, in order to determine whether or not
to pay for material testing, an analysis of outcomes under various testing scenarios is
performed to nd the expected value of perfect and imperfect information.

Conclusion
Hawthorne Plastics' decision on the production process for polypropylene strapping
necessitates a multifaceted approach. By meticulously analyzing costs, probabilities, and
potential revenues, and by assessing the value of additional information, the company can
make an informed decision that aligns with its strategic objectives and maximizes pro tability.

1 I drew the decision tree on paper to help in my calculations as I have a Mac and was not able
to download the decision tree add-in for Excel.
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 Question 1:
In order to determine which process to select, an expected value calculation of the pro ts
under di erent conditions of raw material quality (long chain and short chain) without testing
was performed.

Referring to Exhibit 1, we can see that the pro ts under Process 1 remain constant at $16,800
since the probability of producing high-quality strapping is 0 for both long and short chain
inputs.

For Processes 2 and 3, the calculation incorporates the di erent pro t levels for long and short
chains, as well as the probability of high-quality material. For Process 3 with a long chain, the
pro t is $24,500, and with a short chain, it's $12,000.

For Process 2, the probability of maintaining pressure over 150 PSI is also incorporated into
the calculation. Using the historical data provided in the case, the probability of maintaining
high pressure is about 60%. Given the probability of the raw material being long-chain is 50%,
the value used to calculate the expected value of pro ts under Process 2 is 0.3, corresponding
to the joint probability calculation of 0.5 * 0.6. Therefore for Process 2 with a long chain, the
pro t is $16,800, and with a short chain, it's $14,500.

Considering the probabilities are 0.5 for both long and short chains (since no testing is done,
we assume equal likelihood), the expected values for each process are as follows:

Process 1: $16,800
Process 2: $17,500
Process 3: $17,000

From these expected values, Mr. Nelson should select Process 2 as it has the highest
expected pro t of $17,500. This is the process that maximizes expected pro t under the
scenario without testing.

Question 2:
In order to calculate the expected values for each process when the test observes either "large
molecule” or “standard molecule,” the probability of each test result must be determined.
Summarized in Exhibit 2, we can see that the variation in the test’s accuracy rate increases the
probability of getting a “large molecule” result to 60%. However, this does not mean that the
probability of getting a large molecule actually increases, it just means that 60% of the time,
Nelson should work under the assumption that the raw material is of the long chain variety. The
cost of testing ($200) was subtracted from the expected values to account for the trade-o
required for access to information. However, since the cost is the same for each process, it
does not a ect the decision rule based on the relative comparison of expected values.

The optimal decision rule is determined by considering the expected values for each process
when the test observes either 'large molecule' or 'standard molecule’.

For the test result “Large Molecule,” the expected values are:

Process 1: Constant pro t of $16,600

Process 2: Expected value of $19,100
Process 3: Expected value of $19,800

For the test result “Standard Molecule,” the expected values are:
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Process 1: Constant pro t of $16,600
Process 2: Expected value of $14,600
Process 3: Expected value of $12,300

Optimal Decision Rule

The decision rule is based on the highest expected pro t for each possible test outcome. It is
essential to choose the process that maximizes expected pro t while taking into account the
accuracy of the test results and the di erent probabilities of achieving PSI>150 for Process 2.

Based on the expected values calculated, if the test result is “large molecule”, Nelson
should choose Process 3, since it has the highest expected value ($19,800). If the test
result is “standard molecule”, Nelson should choose Process 1, since it has the highest
expected value ($16,600) among the processes for a standard molecule size result.

Exhibit 2
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 Question 3:

The expected value of information has been calculated for both imperfect and perfect
information scenarios (Exhibit 3).

The expected value of imperfect information was calculated as:

Best Outcome, Standard Result (16,600) * Probability of Standard Result (0.4) + Best
Outcome, Large Result (19,800) * Probability of Large Result (0.6)

The expected value with imperfect information is $18,520. Subtracting the highest expected
value with no information ($17,500), we get the expected value of imperfect information, which
is $1020. That is how much the expected pro t increases by using the information from the
test, after accounting for the cost of the test ($200).

The expected value of perfect information was calculated as:

Best Outcome, Standard Result (16,600) * Probability of Standard Result (0.5) + Best
Outcome, Large Result (21,800) * Probability of Large Result (0.5).

The expected value with perfect information is $19,200. Subtracting the expected value with no
information ($17,500), we get $1700. Therefore, the perfect information, if it could be obtained
for the same price, would be worth $1700 in terms of expected value. That is how much more
pro t could be expected if the quality of the material could be known with certainty.

The comparison indicates that perfect information is more valuable than imperfect information,
as expected. However, since perfect information is rarely attainable in practice, Nelson should
still pay for imperfect information, which valued at $1020, more than justi es the cost of $200.
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Exhibit 3