QUESTION ONE (a) Mr. Sak is interested in developing and marketing a new drug. The cost of extensive research to develop the drug would be 100,000. The manager of research programme said that there is 60% chance that the drug will be developed successfully. The market potential is assessed as follows with present value of profit: Market conditions Probability Present value of profits. Large market potential 0.1 500,000 Moderate market potential 0.6 220,000 Low market potential 0.3 80,000 The present value figures do not include the cost of research. While Mr. Sakala was considering this proposal, another similar proposal came up which also required the investment of 100,000. The present value of profit for the second proposal was 120,000. The return on the investment in the second proposal is almost certain. i. Draw a decision tree for Mr. Sak indicating all choices and events ii. What decision Mr. Sak should take regarding the investment of 100,000? iii. If Mr. Sak is a risk averter, should he change the decision given by you?
QUESTION ONE
(a) Mr. Sak is interested in developing and marketing a new drug. The cost of extensive
research to develop the drug would be 100,000. The manager of research programme said
that there is 60% chance that the drug will be developed successfully. The market potential
is assessed as follows with present value of profit:
Market conditions Probability Present value of profits.
Large market potential 0.1 500,000
Moderate market potential 0.6 220,000
Low market potential 0.3 80,000
The present value figures do not include the cost of research. While Mr. Sakala was
considering this proposal, another similar proposal came up which also required the
investment of 100,000. The present value of profit for the second proposal was 120,000.
The
i. Draw a decision tree for Mr. Sak indicating all choices and events
ii. What decision Mr. Sak should take regarding the investment of 100,000?
iii. If Mr. Sak is a risk averter, should he change the decision given by you?
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