solution to chapter 8 case study exercise (biotekno)

IE5203 (2021) soln-8-1

IE5203 Decision Analysis Solutions to Chapter 8 Case Study Exercise (Biotekno)

Decision Basis Development Decision Variables: 1. Partnership?

a) No partner b) Joint venture Partnership c) Royalty partnership

2. Build new plant?

a) Build new plant b) Don't build new plant

Business Strategies: I. No partner, build new plant II. No partner, don’t build new plant III. Joint venture partner, build new plant IV. Royalty partnership, don’t build new plant Uncertain Variables • nB: number of units sold, if marketed by Biotekno (million) • nN: number of units sold, if marketed by National Diagnostics (million) • g: annual growth rate, %. • c: cost of production (million $) • p: plant cost (million $) Decision Diagram and Tree Influence Diagram

Business Strategy

# sold if marketed by ND nN

# sold if marketed by Bio nB

Plant cost p

Sales growth rate g

Unit cost c

Sales

Profit

IE5203 (2021) soln-8-2

The Generic Decision Tree

Value (Business) Model Alternative I: No partner, Build new plant:

pgncpgnnc

B

BB

−+−=−++−=

)2()20()]1()[20(1π

Alternative II: No partner, No new plant:

)]4,)1min(()4,)[min(20(2 BB ngnc ++−=π Alternative III: Joint venture partner, Build new plant:

)2()20(5.0)]1()[20(5.03

gncgnnc

N

NN

+−=++−=π

Alternative IV: Royalty partner, No new plant:

)2()20(02.0)]1()[20(02.04

gngnn

N

NN

+=++=π

nB g c p π1

nB g c π2

nN g c π3

nN g π4

No new partner, Build new plant

No new partner, No new plant

Joint venture partner, Build new plant

Royalty partner, No new plant

IE5203 (2021) soln-8-3

Deterministic Structuring Deterministic Base Case Analysis • The base values for all the variable are: • The 2-year profit for the four alternatives are:

Alternative 2-year profit ($million) I No partner, new plant 57.600 II No partner, no plant 72.600 III Joint venture partner, new plant 48.400 IV Royalty partner, no plant 3.520

One-Way Range Sensitivity Analysis • The low, base, and high values based on 5, 50, and 95 percentiles are:

Variables Symbol Low Base High Plant construction cost (million $) p 10 15 20 Sales growth rate (%) g -10 20 50 Sales, 1st year, Biotekno (million $) nB 1 3 5 Sales, 1st year, National Diagnostics (million $) nN 1 4 7 Unit production cost ($) c 7 9 11

Variables Symbol Base Value Plant construction cost (million $) p 15 Sales growth rate (%) g 20 Sales, 1st year, Biotekno (million $) nB 3 Sales, 1st year, National Diagnostics (million $) nN 4 Unit production cost ($) c 9

IE5203 (2021) soln-8-4

Alternative I: No partner, Build new plant

Input Variables No partner, Build new plant Variable Low Base High Low Base High Swing

nB 1 3 5 9.200 57.600 106.000 96.800 c 11 9 7 44.400 57.600 70.800 26.400 g -0.1 0.2 0.5 47.700 57.600 67.500 19.800 p 20 15 10 52.600 57.600 62.600 10.000 nN 1 4 7 57.600 57.600 57.600 0.000

Alternative II: No partner, No new plant

Input Variables No partner, No new plant Variable Low Base High Low Base High Swing

nB 1 3 5 24.200 72.600 88.000 63.800 c 11 9 7 59.400 72.600 85.800 26.400 g -0.1 0.2 0.5 62.700 72.600 77.000 14.300 nN 1 4 7 72.600 72.600 72.600 0.000 p 10 15 20 72.600 72.600 72.600 0.000

1

11

-0.1

20

1

5

7

0.5

10

7

-10.000 0.000 10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 90.000 100.000 110.000 120.000

No. of units sold if marketed by National Diagnostics (million)

Cost of production ($ million)

Annual growth rate

Plant Cost ($ million)

No. of units sold if marketed by Biotechno (million)

No partner, new plant

1

11

-0.1

1

10

5

7

0.5

7

20

10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 90.000 100.000



Annual growth rate



No partner, no plant

IE5203 (2021) soln-8-5

Alternative III: Joint venture partner, Build new plant

Input Variables Joint venture partner, New plant Variable Low Base High Low Base High Swing

nN 1 4 7 12.100 48.400 84.700 72.600 c 11 9 7 39.600 48.400 57.200 17.600 g -0.1 0.2 0.5 41.800 48.400 55.000 13.200 nB 1 3 5 48.400 48.400 48.400 0.000 p 10 15 20 48.400 48.400 48.400 0.000

Alternative IV: Royalty partner, No new plant

Input Variables Joint venture partner, New plant Variable Low Base High Low Base High Swing

nN 1 4 7 0.880 3.520 6.160 5.280 g -0.1 0.2 0.5 3.040 3.520 4.000 0.960 nB 1 3 5 3.520 3.520 3.520 0.000 c 7 9 11 3.520 3.520 3.520 0.000 p 10 15 20 3.520 3.520 3.520 0.000

1

11

-0.1

1

10

7

7

0.5

5

20

0.000 10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 90.000 100.000



Annual growth rate



Joint venture parnter, new plant

1

-0.1

1

7

10

7

0.5

5

11

20

-1.000 0.000 1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000


Annual growth rate




Royalty partner, no plant

IE5203 (2021) soln-8-6

Combined Tornado Diagrams

Results of Deterministic Sensitivity • The sales variables are much more sensitive than the other variables. • Sensitive variables: nN and nB. Tornado Dominance • The best outcomes for alternative IV are always worse than the worst outcomes for alternatives

I, II and III. • Hence alternative IV can be dropped from further consideration.

0 10 20 30 40 50 60 70 80 90 100 110 120


Annual growth rate






Annual growth rate




Annual growth rate





Annual growth rate




57.6

72.6

48.4

3.52 1st year by Biotekno

Production Cost

Sales Growth Rate

1st year by Nat Diag

Plant Construction Cost

-9 -6 -3 0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 102 105 108 111 114

Investment Strategy: No partner New plant Investment Strategy: No partner No new plant Investment Strategy: New partner New plant Investment Strategy: Royalty partner

Initial Decision Alternatives Tornado

IE5203 (2021) soln-8-7

Probabilistic Evaluation The Reduced Decision Model

The Reduced Value Model

152.2415)2.02()920(1

−=−+−=

B

B

nnπ

))4,2.1min()4,(min(11))3,2.1min()3,)(min(920(2

BB

BB

nnnn

+=+−=π

N

N

nn

1.12)2.02()920(5.03

=+−=π

Business Strategy

nN

Sales Profit

NB

nB π1

nB π2

nN π3

No new partner, Build new plant

No new partner, No new plant

Joint venture partner, Build new plant

IE5203 (2021) soln-8-8

Assessing Probability Distributions for nB and nN Using the 5, 50, and 95 percentiles: • nB may be represented by a Normal distribution with

Mean = 3 Standard deviation = 1.216

• nN may be represented by a Normal distribution with

Mean = 4 Standard deviation = 1.824

Using moments matching method, the 3-branch discrete approximations for the two variables are:

nB nN Value Probability Value Probability 0.8938 1/6 0.8407 1/6 3.0000 2/3 4.0000 2/3 5.1062 1/6 7.1593 1/6

The Decision Tree and Optimal Decision Policy

The best decision is: Alternative II: No Partner, No new plant.

6.6306 .1667 [6.6306] Low

57.6000 .6667 [57.6000] Nominal

108.5694 .1667 [108.5694] High

Sales 1st year by Biotekno [57.6000] No partner N …

21.6306 .1667 [21.6306] Low

72.6000 .6667 [72.6000] Nominal

88.0000 .1667 [88.0000] High

Sales 1st year by Biotekno [66.6718] No partner N …

10.1729 .1667 [10.1729] Low

48.4000 .6667 [48.4000] Nominal

86.6271 .1667 [86.6271] High

Sales 1st year by Nat Diag [48.4000] New partner …

Investment Strategy [66.6718]

IE5203 (2021) soln-8-9

Risk Profiles and Stochastic Dominance Analysis

Observation: • Alt II first order stochastically dominates Alt III • Alt II second order stochastically dominates Alt I Alternative III will never be chosen under all attitudes (risk advise and risk seeking) Alternative I will never be chosen under all risk averse consideration. Recommendation: Chose Alternative II - Do not go with partner, do not build plant. Expected Profit under 2-year study period = $66.6718 million

5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 105

Value of Objective Function

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

Prob

abilit

y of

Exc

eedi

ng

No partner New plantNo partner No new plantNew partner New plant

IE5203 (2021) soln-8-10

Value of Information Analysis EVPI for nB Decision model with free perfect information on nB

Expected Value of Perfect Information for nB = 74.5616 – 66.6718 = $7.8898 million.

6.6306 [6.6306] No partner Ne …

21.6306 [21.6306] No partner N …

10.1729 .1667 [10.1729] Low

48.4000 .6667 [48.4000] Nominal

86.6271 .1667 [86.6271] High


Investment Strategy

.1667 [48.4000] Low

57.6000 [57.6000] No partner N …

72.6000 [72.6000] No partner N …

10.1729 .1667 [10.1729] Low

48.4000 .6667 [48.4000] Nominal

86.6271 .1667 [86.6271] High


Investment Strategy

.6667 [72.6000] Nominal

108.5694 [108.5694] No partner …

88.0000 [88.0000] No partner N …

10.1729 .1667 [10.1729] Low

48.4000 .6667 [48.4000] Nominal

86.6271 .1667 [86.6271] High


Investment Strategy

.1667 [108.5694] High

Sales 1st year by Biotekno [74.5616]

IE5203 (2021) soln-8-11

EVPI for nN Decision model with free perfect information on nN

Expected Value of Perfect Information for nN = 69.9976 – 66.6718 = $3.3258 million.

6.6306 .1667 [6.6306] Low

57.6000 .6667 [57.6000] Nominal

108.5694 .1667 [108.5694] High

Sales 1st year by Biotekno [57.6000] No partner …

21.6306 .1667 [21.6306] Low

72.6000 .6667 [72.6000] Nominal

88.0000 .1667 [88.0000] High


10.1729 [10.1729] New partner …

Investment Strategy

.1667 [66.6718] Low

6.6306 .1667 [6.6306] Low

57.6000 .6667 [57.6000] Nominal

108.5694 .1667 [108.5694] High


21.6306 .1667 [21.6306] Low

72.6000 .6667 [72.6000] Nominal

88.0000 .1667 [88.0000] High


48.4000 [48.4000] New partner …

Investment Strategy

.6667 [66.6718] Nominal

6.6306 .1667 [6.6306] Low

57.6000 .6667 [57.6000] Nominal

108.5694 .1667 [108.5694] High


21.6306 .1667 [21.6306] Low

72.6000 .6667 [72.6000] Nominal

88.0000 .1667 [88.0000] High


86.6271 [86.6271] New partner …

Investment Strategy

.1667 [86.6271] High

Sales 1st year by Nat Diag [69.9976]

IE5203 (2021) soln-8-12

Joint EVPI for nN and nB Decision model with free joint perfect information on nN and nB

Expected Value of Joint Perfect Information for nN and nB = 76.4384 – 66.6718 = $9.7666 million.

6.6306 [6.6306] No partner …

21.6306 [21.6306] No partn …

10.1729 [10.1729] New part …

Investment Strategy

.1667 [21.6306] Low

57.6000 [57.6000] No partn …

72.6000 [72.6000] No partn …

10.1729 [10.1729] New part …

Investment Strategy

.6667 [72.6000] Nominal

108.5694 [108.5694] No part …

88.0000 [88.0000] No partn …

10.1729 [10.1729] New part …

Investment Strategy

.1667 [108.5694] High

Sales 1st year by Biote …

.1667 [70.1000] Low

6.6306 [6.6306] No partner …

21.6306 [21.6306] No partn …

48.4000 [48.4000] New part …

Investment Strategy

.1667 [48.4000] Low

57.6000 [57.6000] No partn …

72.6000 [72.6000] No partn …

48.4000 [48.4000] New part …

Investment Strategy

.6667 [72.6000] Nominal

108.5694 [108.5694] No part …

88.0000 [88.0000] No partn …

48.4000 [48.4000] New part …

Investment Strategy

.1667 [108.5694] High


.6667 [74.5616] Nominal

6.6306 [6.6306] No partner …

21.6306 [21.6306] No partn …

86.6271 [86.6271] New part …

Investment Strategy

.1667 [86.6271] Low

57.6000 [57.6000] No partn …

72.6000 [72.6000] No partn …

86.6271 [86.6271] New part …

Investment Strategy

.6667 [86.6271] Nominal

108.5694 [108.5694] No part …

88.0000 [88.0000] No partn …

86.6271 [86.6271] New part …

Investment Strategy

.1667 [108.5694] High


.1667 [90.2841] High

Sales 1st year by Nat Diag [76.4384]

IE5203 (2021) soln-8-13

Areas of Further Consideration • Why were the pricing issues fixed and not a decision variable? • Are there other ways to expand existing production capacity? • Would the partnership offer be more attractive if Biotekno explicitly considered the cost of

marketing the product? • The sales distribution seems rather tight. There may be an anchoring bias. • It doesn't seem reasonable that a small company would be risk neutral in this range of values. • The no partnership/build plant alternative might be more attractive if possible uses of the plant

beyond two years were considered. • The two-year time frame seems unrealistic, despite fast product cycles.

solution to chapter 8 case study exercise (biotekno)

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