Question

Hemmingway, Inc., is considering a $6 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project wlll be successful Is only 0.40. Furthermore, the president knows that even If the project successful, It will require that the company build a new production facility at a cost of $16 million in order to manufacture the product. If the facility is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D the product for an estimated $25 million. Under this option, the company would not build the $16 million production facility. successful, the company could sell the rights project FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Profit ($ millions) High Demand 40 0.5 Building Facility ($16 million) Medium Demand 23 03 Low Demand 13 0 2 Successful 3 04 Start R&D Proicct ($6million) Sell Rights 19 1 Not Successful 0.6 Do Not Start the R&D Project The decision tree s shown in Figure 13.18. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $62 $6-$16 $40 million. Branch probabilities million, However, the cost the R&D project ($6 million) and the cost f the production facility ($16 million) show the profit of this outcome to be $62 are also shown for the chance events. a. Analyze the declslon tree to determine whether the company should undertake the R&D project. If It does, and If the R&D project is successful, what should the company do? Yes, the company should start the R&D project and if it is successful, then the company should not build the facility. What is the expected value of your strategy? If required, round your answer to 2 decimal places. M Expected value $ b. What must the selling price be for the company to consider selling the rights to the product? If required, round your answers to decimal places. Payoff for sell rights would have to be $ M or more. In order to recover the $6M R&D cost, the selling price would have to be $ M or more. :. Develop a risk profile for the optimal strategy. If required, round your answers two decimal places. Associated Probability Possible Profit $40M $23M $13M -$6M

Answer 1

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