Sarah Chang is the owner of a small electronics company. In six months, a proposal is due for an electronic timing system for the next Olympic Games. For several years, Chang’s company has been developing a new microprocessor, a critical component in a timing system that would be superior to any product currently on the market. However, progress in research and development has been slow, and Chang is unsure whether her staff can produce the microprocessor in time. If they succeed in developing the microprocessor (probability p1), there is an excellent chance (probability p2) that Chang’s company will win the $1 million Olympic contract. If they do not, there is a small chance (probability p3) that she will still be able to win the same contract with an alternative but inferior timing system that has already been developed. If she continues the project, Chang must invest $200,000 in research and development. In addition, making a proposal (which she will decide whether to do after seeing whether the R&D is successful) requires developing a prototype timing system at an additional cost. This additional cost is $50,000 if R&D is successful (so that she can develop the new timing system), and it is $40,000 if R&D is unsuccessful (so that she needs to go with the older timing system). Suppose now that this is a relatively big project for Chang. Therefore, she decides to use expected utility as her criterion, with an exponential utility function. Using some trial and error, see which risk tolerance changes her initial decision from “go ahead” to “abandon” when p1= 0.4, p2 = 0.8, and p3 = 0.1.

Practical Management Science

6th Edition

ISBN:9781337406659

Author:WINSTON, Wayne L.

Publisher:WINSTON, Wayne L.

Chapter2: Introduction To Spreadsheet Modeling

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Sarah Chang is the owner of a small electronics

company. In six months, a proposal is due for an

electronic

timing system for the next Olympic

Games. For several years, Chang’s company has been

developing a new microprocessor, a critical component

in a timing system that would be superior

to any product currently on the market. However,

progress in research and development has been

slow, and Chang is unsure whether her staff can

produce the microprocessor

in time. If they succeed

in developing the microprocessor (probability

p1), there is an excellent chance (probability p2) that

Chang’s company will win the $1 million Olympic

contract. If they do not, there is a small chance

(probability p3) that she will still be able to win the

same contract with an alternative but inferior timing

system that has already been developed.

If she continues the project, Chang must invest

$200,000 in research and development. In addition,

making a proposal (which she will decide whether

to do after seeing whether the R&D is successful)

requires developing a prototype timing system at an

additional cost. This additional cost is $50,000 if R&D

is successful (so that she can develop the new timing

system), and it is $40,000 if R&D is unsuccessful (so

that she needs to go with the older timing system).

Suppose now that this is a relatively big project for Chang. Therefore, she decides to use expected utility as her criterion, with an exponential utility function. Using some trial and error, see which risk tolerance changes her initial decision from “go ahead” to “abandon” when p1= 0.4, p2 = 0.8, and p3 = 0.1.

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