Answered: FIGURE 13.18 DECISION TREE FOR…

Practical Management Science

6th Edition

ISBN:9781337406659

Author:WINSTON, Wayne L.

Publisher:WINSTON, Wayne L.

Chapter2: Introduction To Spreadsheet Modeling

Section: Chapter Questions

Problem 20P: Julie James is opening a lemonade stand. She believes the fixed cost per week of running the stand...

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$### Decision Analysis for R&D Projects: Hemmingway, Inc. Case Study **Problem Statement:** Hemmingway, Inc. is considering a $5 million research and development (R&D) project. While the profit projections appear promising, the company president is concerned due to the 0.50 probability of the R&D project being successful. Additionally, even with a successful R&D project, a new production facility, costing $20 million, will be required to manufacture the product. There are uncertainties about demand and the resultant profits even if the facility is built. Alternatively, Hemmingway, Inc. can sell the rights to the product for $25 million if the R&D project is successful, thereby avoiding the need to build the new production facility. **Decision Tree Analysis:** The accompanying decision tree (Figure 13.18) is crucial in this analysis. It projects the potential profit for each outcome: - For high demand, the revenue projection is $59 million. - Considering the costs of the R&D project ($5 million) and the production facility ($20 million), the profit in this scenario is calculated as: \[ \text{Profit} = \$59\text{ million} - \$5\text{ million} - \$20\text{ million} = \$34\text{ million} \] Branch probabilities for different chance events are also outlined in the decision tree. **Key Considerations:** a. **Decision Tree Analysis:** - Determine whether Hemmingway, Inc. should undertake the R&D project. - If the R&D project proceeds and is successful, determine the subsequent steps for maximizing profits. - Calculate the expected value of the strategy. b. **Selling Rights Evaluation:** - Assume Hemmingway, Inc. opts to sell the rights to the product. - Determine the minimum selling price beneficial for the company compared to building the production facility. c. **Risk Profile Development:** - Create a risk profile for the optimal strategy choice. - Assess the potential risks and returns through probabilistic analysis. By carefully analyzing these aspects, Hemmingway, Inc. can make an informed decision regarding whether to pursue the R&D project, build the new production facility, or sell the product rights. Each route has its own set of financial implications and risks, which must be evaluated comprehensively.$

Transcribed Image Text:### Decision Analysis for R&D Projects: Hemmingway, Inc. Case Study **Problem Statement:** Hemmingway, Inc. is considering a $5 million research and development (R&D) project. While the profit projections appear promising, the company president is concerned due to the 0.50 probability of the R&D project being successful. Additionally, even with a successful R&D project, a new production facility, costing $20 million, will be required to manufacture the product. There are uncertainties about demand and the resultant profits even if the facility is built. Alternatively, Hemmingway, Inc. can sell the rights to the product for $25 million if the R&D project is successful, thereby avoiding the need to build the new production facility. **Decision Tree Analysis:** The accompanying decision tree (Figure 13.18) is crucial in this analysis. It projects the potential profit for each outcome: - For high demand, the revenue projection is $59 million. - Considering the costs of the R&D project ($5 million) and the production facility ($20 million), the profit in this scenario is calculated as: \[ \text{Profit} = \$59\text{ million} - \$5\text{ million} - \$20\text{ million} = \$34\text{ million} \] Branch probabilities for different chance events are also outlined in the decision tree. **Key Considerations:** a. **Decision Tree Analysis:** - Determine whether Hemmingway, Inc. should undertake the R&D project. - If the R&D project proceeds and is successful, determine the subsequent steps for maximizing profits. - Calculate the expected value of the strategy. b. **Selling Rights Evaluation:** - Assume Hemmingway, Inc. opts to sell the rights to the product. - Determine the minimum selling price beneficial for the company compared to building the production facility. c. **Risk Profile Development:** - Create a risk profile for the optimal strategy choice. - Assess the potential risks and returns through probabilistic analysis. By carefully analyzing these aspects, Hemmingway, Inc. can make an informed decision regarding whether to pursue the R&D project, build the new production facility, or sell the product rights. Each route has its own set of financial implications and risks, which must be evaluated comprehensively.