- The best custom writing site
- +1 (315) 215-1164
- info@goldentechessays.com

General Ford (GF) Auto Corporation is developing a new type of compact car. This car is

assumed to generate sales for the next 10 years. GF has gathered information about the

following quantities through focus groups with the marketing and engineering departments.

• Fixed cost of developing car. This cost is assumed to be normally distributed with mean and

standard deviation $2.3 billion and $0.5 billion. The fixed cost is incurred at the beginning of

year 1, before any sales are recorded.

• Variable production cost. This cost, which includes all variable production costs required to

build a single car, is assumed to be normally distributed during year 1 with mean and

standard deviation $7800 and $600. Each year after year 1, the variable production cost is

the previous year’s variable production cost multiplied by an inflation factor. Each year this

inflation factor is assumed to be normally distributed with mean 1.05 (a 5% increase) and

standard deviation 0.015. All production costs are assumed to occur at the ends of the

respective years.

• Selling price. The price in year 1 is already set at $11,800. After year 1 the price will increase

by the same inflation factor that drives production costs. Like production costs, revenues

from sales are assumed to occur at the ends of the respective years.

• Demand. The demand for the car in year 1 is assumed to be normally distributed with mean

100,000 and standard deviation 10,000. After year 1 the demand in a given year is assumed

to be normally distributed with mean equal to the actual demand in the previous year and

standard deviation 10,000. For example, if the observed demand in year 3 is 105,000, then

the demand distribution in year 4 has mean 105,000. An implication of this assumption is

that demands in successive years are not probabilistically independent. For example, if the

demand in one year is large, the mean demand for the next year is also large, so that the

actual demand for the next year will tend to large.

• Production. In any particular year GF plans to base its production policy on the probability

distribution of demand for that year – before the actual demand for that year is observed.

In particular, if the expected demand in year t is μ and standard deviation of demand is σ,

then GF’s policy is to produce μ + k * σ cars, where k is a multiple that GF will have to select.

For example, if it chooses k = 1, then its production quantity in any year will be one standard

deviation above the mean of demand. From the properties of the normal distribution, using

k = 1 implies that the chances are approximately 5 out of 6 of meeting demand for the year.

(This is because a normal random variable has approximate probability 5/6 of being no more

than one standard deviation above the mean.) If demand in any year is greater than

production, the excess demand is lost. However, if production in any year is greater than

demand, GF will sell the excess cars at an end-of-year discount of 30%.

• Interest rate. GF plans to use a 10% interest rate to discount future cash flows. This means,

for example, that a cash flow of $1 at the beginning of year 1 is equivalent to a to cash flow

of $1.10 at the end of year 1.

Analysis

Given these assumptions, develop a simulation model with Excel + @RISK that will evaluate

the net present value (NPV) for this new car over the 10-year time horizon.

Considerations to be included:

• An analysis of pros and cons of various k multiples that have been considered for the

production policy;

• A recommendation to GF with respect to which value of k multiple should be in the

production policy; and

• Assuming demands for the new car over the 10 years are independently normally

distributed with mean 100,000 and standard deviation 10,000:

o Please comment on differences with respective to relevant aspects associated with

the new car business analysis, between this demand scenario and the previous

scenario in which demands in successive years are not probabilistically independent;

and

o Recommend a k multiple for the production policy under this demand scenario.