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Question 1

In our computations, we have ignored the time value of money. Today Orion has to decide whether to deliver to Avion 50 old valves or to invest in, and eventfully manufacture, 50 new valves. If it decides to deliver old valves, the price per valve is \$10,000 and the variable cost per valve is \$8,000. If Orion decides to invest in the new valve, it has to spend \$120,000 to develop new software. If Armstrong makes the decision to design and deliver the new valve regardless of the economic consequences in order to uphold the reputation of his firm as the industry leader, then the company will have to go through all the stages of the supersmart valve development from development of the new software to valve redesign. The decision tree for this scenario is shown in exhibit 1

The probabilities at each stage of the valve development process and the relative cash flows could be seen in the above decision tree. Based upon the assumptions in this scenario the total expected monetary value for developing the new valves for Avion is \$ 105,500. However, if the company plans to deliver the old valves then the expected monetary value would be equal to the profit for delivering 50 valves. This is equal to \$ 100,000. It could be seen that the expected monetary value for designing and delivering the supersmart valves is higher than the value of the old valves therefore, it is recommended for Orion to develop and deliver the supersmart valves since it would yield higher value and profitability for the business.

Question 2

In this question, we consider another option and assume that now the economic consequences are also important for Orion, which means that if the improvements in the valve were modest then Orion would decide to deliver the old valves. Also, if the short cut method for the development of the software fails, then again Orion management would decide to supply the old valves to Avion. The decision tree based upon these assumptions with all the relative cash flows and probabilities at each stage of the process could be seen in exhibit 2.

Based upon the above set of assumptions, the total expected monetary value for developing the new valves for Avion is \$ 225,000. However, if the company plans to deliver the old valves then the expected monetary value would be equal to the profit for delivering 50 valves. This is equal to \$ 100,000. It could be seen that the expected monetary value for designing and delivering the supersmart valves considering the importance of the economic consequences is higher than the value of the old valves therefore, it is recommended for Orion to develop and deliver the supersmart valves since it would yield higher value and profitability for the business…………………

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