Case: Omega Paints

Omega paints is one of the leading manufacturers of paints. They want to launch a new product
into the market. To launch the product, the management is undecided, as how much investment
is needed to be carried out in capacity building. They have three choices in capacity investment
related decisions. Either they can go for a large capacity, a medium sized capacity or a small
sized capacity. Based on their respective sizes, the investment decisions are also affected.
Further, any capacity installed will have a useful life of 5 years. After 5 years the built capacity,
will have no salvage value. The management first hired a market research firm to gather some
information about the potential market size and chances about the success of the product. The
market research firm predicted the possible states of demand of the new product based on how
well the product is being received in the market with some probability values for all the future
states of demand. Moreover, it was also predicted that if the market condition is favorable, the
demand will increase at rate of 20% every year, whereas in normal market conditions, the growth
rate is expected to be 5% every year. However, if the market condition is unfavorable, then there
will be a decline in sales at the rate of 5% every year. Further, it is learnt that the contribution
margin that can be obtained by selling each unit of the product is $10. Suppose that you are a
part of the management and have to take a decision on the basis of the data available in the
following tables. [Assume that the management is risk neutral and takes a decision on the basis
of maximizing expected monetary value and time value of money is ignored].
Table 1: States of demand
State
Favorable
Normal
Unfavorable

Demand
30000
20000
6000

Probability
0.3
0.4
0.3

Table 2: Capacity Investment

Decision

Investment

Large Capacity
Medium Capacity
Small Capacity

$600000
$300000
$100000

Maximum
Production
Limit
60000
25000
10000