Concept explainers
Hemmingway, Inc. is considering a $5 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 will be successful is only 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 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 project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million production facility.
The decision tree follows. 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 $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59 – $5 – $20 = $34 million. Branch probabilities are also shown for the chance events.
- a. Analyze the decision 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? What is the
expected value of your strategy? - b. What must the selling price be for the company to consider selling the rights to the product?
- c. Develop a risk profile for the optimal strategy.
Want to see the full answer?
Check out a sample textbook solutionChapter 15 Solutions
Essentials of Business Analytics (MindTap Course List)
- A Statistics professor has observed that for several years students score an average of 112 points out of 150 on the semester exam. A salesman suggests that he try a statistics software package that gets students more involved with computers, predicting that it will increase students' scores. The software is expensive, and the salesman offers to let the professor use it for a semester to see if the scores on the final exam increase significantly. The professor will have to pay for the software only if he chooses to continue using it. In the trial course that used this software, 249 students scored an average of 114 points on the final with a standard deviation of 8.4 points. Complete parts a) and b) below. A. Fail to reject Ho. The change is not statistically significant. The software does not appear to improve exam scores. B. Fail to reject Ho. The change is statistically significant. The software does appear to improve exam scores. C. Reject Ho. The change is not statistically…arrow_forwardThe Harriet Hotel in downtown Boston has 100 rooms that rent for $150 per night. It costs the hotel $30 per room in variable costs (cleaning, bathroom items, etc.) each night a room is occupied. For each reservation accepted, there is a 5% chance that the guest will not arrive. If the hotel overbooks, it costs $200 to compensate guests whose reservations cannot be honored. How many reservations should the hotel accept if it wants to maximize the average daily profit?arrow_forwardA customer has approached a bank for a $50,000 one-year loan at 12% interest. If the bank does not approve the loan, the $50,000 will be invested in bonds that earn a 6% annual return. WIthout further information, the bank feels that there is a 4% chance that the customer will totally default on the loan. If the customer totally defaults, the bank loses $50,000. At a cost of $500, the bank can thoroughly investigate the customer's credit record and supply a favorable or unfavorable recommendation. Past experiences indicates that p(favorable recommendations|customer does not default) =77/96 p(favorable recommendations|customer defaults)= 1/4 How can the bank maximize its expected profits? Find EVSI and EVPI.arrow_forward
- A group of medical professionals is considering constructing a private clinic. If a patient demand for the clinic is high, the physicians could realize a net profit of $120,000. If the demand is low, they could lose $55,000. Of course, they do not have to proceed at all, in which case there is no cost. In the absence of any market data, the best the physicians can guess is that there is a 50-50 chance the demand would be high. a) Create a decision tree. b) What should the medical professionals do? What is the payoff? c) The physicians have been approached by a market research firm that offers to perform a study of the market at a fee of $5,000. The market researchers claim that their experience enables them to use Bayes’ theorem to make the following statements of probability: -probability of high demand given a positive survey result = 0.82 -probability of low demand given a positive survey result = 0.18 -probability of high demand given a negative survey result = 0.11 -probability of…arrow_forwardWhile the stock and bond markets can be risky in the short run, time has a moderating effect on market risk. The longer you hold a stock or bond investment, the lower your chances of losing money, and the greater the odds of earning a return close to the long-term average. For example, a one-year investment in stocks has historically produced returns ranging from +53.9% to -43.3%. Over ten-year periods, however, returns have varied from -0.9% per year for the worst ten years to +20.1% per year for the best ten years. Holding Period Best Return Worst Return 1 Year +53.9% -43.3% 5 Years +23.9% -12.5% 10 Years +20.1% -0.9% 15 Years +18.2% +0.6% 20 Years +16.9% +3.1% 25 Years +14.7% +5.9% As you can see, risk can be substantial over short periods. But over longer horizons, the chance of losing money is substantially reduced. The same principle applies to bonds, though bonds are less risky than stocks. For long-term bonds, it takes ten years before returns are consistently…arrow_forwardThe ABC Company is involved in the production and selling of consumer goods, particularly beauty products such as bath soap and shampoo and had registered a positive profit growth for the last 10 years. However, the current year seems to be different from those years as the company is expecting a decline in profit; which is estimated to be about 70% below the target. The manager now is in a dilemma … asking himself/herself “What happened, why this decline in profit?” The Manager then asked the company Accountant to give him/her the data on sales and advertising cost for the last 10 years – he/she wants these data to determine whether the company can live without advertising, as advertising cost happens to be substantial. Justify your answer by doing as step-by-step procedure in Correlation Analysis using a 0.05 level of significance. The data are as follows –arrow_forward
- Two investments, X and Y, have the characteristics shown below. E(X) = $60, E(Y) = $90, o = 10,000, o? = 17,000 and axy = 6,500 If the weight of portfolio assets assigned to investment X is 0.8, calculate the a. portfolio expected return and b. portfolio risk. a. If the weight of portfolio assets assigned to investment X is 0.8, the portfolio expected return is $ (Type an integer or a decimal.) b. If the weight of portfolio assets assigned to investment X is 0.8, the portfolio risk is approximately $. (Round to two decimal places as needed.)arrow_forwardA manufacturer produces a toy sold during the summer season at a unit production cost of $5. The manufacturer sells the toy to a retailer, who then sells the product for $35 to the end customer. The manufacturer and retailer have agreed upon a revenue sharing contract that coordinates the supply chain and optimizes the expected profit of the entire supply chain (i.e., the retailer and the manufacturer), which is expected to be $4,000 over the summer selling season. If the wholesale price of the revenue sharing contract is $2, what is the manufacturer’s expected profit? PLEASE SHOW CALCULATIONSarrow_forwardA research analyst is trying to determine whether a firm’s price-earnings (P/E) and price-sales (P/S) ratios can explain the firm’s stock performance over the past year. A P/E ratio is calculated as a firm’s share price compared to the income or profit earned by the firm per share. Generally, a high P/E ratio suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E ratio. The P/S ratio is calculated by dividing a firm’s share price by the firm’s revenue per share for the trailing 12 months. In short, investors can use the P/S ratio to determine how much they are paying for a dollar of the firm’s sales rather than a dollar of its earnings (P/E ratio). In general, the lower the P/S ratio, the more attractive the investment. The accompanying table shows the year-to-date (YTD) returns and the P/E and P/S ratios for a portion of the 30 firms included in the Dow Jones Industrial Average.…arrow_forward
- A study was designed to assess the time to first exit-site infection (in months) in patients with renal insufficiency. In this study, 43 patients utilized a surgically placed catheter and 76 patients utilized a percutaneous placement of their catheter. See Section 1.4 (K&M) for more details. Data from this study is presented in Table 1.2. (a) Give a sensible formulation for the time-to-event problem in this study. Define the event of interest, time origin, and time scale. (b) What is the percentage of censored observations among patients whose catheter was placed surgically? (c) The investigators are interested in testing if there is a difference in the time to cutaneous exit-site infection between patients whose catheter was placed surgically and patients who had their catheters placed percutaneously. Do you think you can answer this question using a two-sample t-test? Provide justifications for your answer. answer a,b, & carrow_forwardThe SAT and ACT exams are often used to predict a student's first-term college grade point average (GPA). Different formulas are used for different colleges and majors. Suppose that a student is applying to a university with an intended major in civil engineering. Also suppose that for this college and this major, the following model is used to predict first term GPA. GPA = a + b(ACT) a = 0.6 b = 0.2 (a) In this context, what would be the appropriate interpretation of the value of a? The value of a is the predicted ACT score of a student who has a 0 GPA. There is not enough information to know how to interpret the value of a. The value of a represents the change in predicted GPA associated with an increase of 1 in ACT score. The value of a represents the change in predicted GPA associated with an decrease of 1 in ACT score. The value of a is the predicted GPA of a student who scored a 0 on the ACT. (b) In this context, what would be the…arrow_forwardThe owner of a small firm has just purchased a personal computer, which she expects will serve her for the next two years The owner has been told that she "must" buy a surge suppressor to provide protection for her new hardware against possible surges or variations in the electrical current, which have the capacity to damage the computer The amount of damage to the computer depends on the strength of the surge. It has been estimated that there is a 1% chance of incurring 350 dollar damage, 4% chance of incurring 200 dollar damage, and 10% chance of incurring 125 dollar damage from a surge within the next two years. An inexpensive suppressor, which would provide protection for only one surge, can be purchased. How much should the owner be willing to pay if she makes decisions on the basis of expected value? Expected value = Preview My Answers Submit Answers You have attempted this problem 0 times. You have unlimited attempts remaining.arrow_forward
- MATLAB: An Introduction with ApplicationsStatisticsISBN:9781119256830Author:Amos GilatPublisher:John Wiley & Sons IncProbability and Statistics for Engineering and th...StatisticsISBN:9781305251809Author:Jay L. DevorePublisher:Cengage LearningStatistics for The Behavioral Sciences (MindTap C...StatisticsISBN:9781305504912Author:Frederick J Gravetter, Larry B. WallnauPublisher:Cengage Learning
- Elementary Statistics: Picturing the World (7th E...StatisticsISBN:9780134683416Author:Ron Larson, Betsy FarberPublisher:PEARSONThe Basic Practice of StatisticsStatisticsISBN:9781319042578Author:David S. Moore, William I. Notz, Michael A. FlignerPublisher:W. H. FreemanIntroduction to the Practice of StatisticsStatisticsISBN:9781319013387Author:David S. Moore, George P. McCabe, Bruce A. CraigPublisher:W. H. Freeman