Travis engineers have proposed a change in metal processing that should result in reduced costs for Travis mower and tractor production. There are three options to fuel this system: natural gas (NG), bunker oil (BO) and wood (W). Each of the three fuels involves different investment costs, operating expense rates and material cost rates.
Operating expenses are functions of the quantity processed, which is expected to be 1 million tons during the first year, growing at the rate of 10% per year. Material cost is also calculated on the basis of a ton of metal processed. Material costs for BO and NG depend on the price of a barrel of oil, P. Specific cost parameters (all in millions of dollars) are given in the table below:
|Investment Year 1||$6||$6||$4|
|Operating expense rate/ton||$0||$0||$2|
|Operating expense rate/ton||$0.50||$0.60||$1.00|
|Material expense/ton||$(0.30 + 0.01P)||$0.02P||$0.10|
There are two major sources of uncertainty. The first is demand growth. The expected rate of growth in metal processed is 10%, but it could easily range from 5% to 15%. Second, the future price of a barrel of oil (P) is highly uncertain. In 1972 it was about $3 per barrel. In the early 1980s, the price rose to about $35 per barrel and has been much higher in recent years. For the purposes of this case, assume that it varies around $15 to $20.