Chapter 21, Problem 21SE

Embassy Publishing Company received a six-chapter manuscript for a new college textbook. The editor of the college division is familiar with the manuscript and estimated a 0.65 probability that the textbook will be successful. If successful, a profit of $750,000 will be realized. If the company decides to publish the textbook and it is unsuccessful, a loss of $250,000 will occur.

Before making the decision to accept or reject the manuscript, the editor is considering sending the manuscript out for review. A review process provides either a favorable (F) or unfavorable (U) evaluation of the manuscript. Past experience with the review process suggests probabilities P(F) = 0.7 and P(U) = 0.3 apply. Let s₁ = the textbook is successful, and s₂ = the textbook is unsuccessful. The editor’s initial probabilities of s₁ and s₂ will be revised based on whether the review is favorable or unfavorable. The revised probabilities are as follows:

P(s1 | F) = 0.75	P(s1 | U ) = 0.417
P(s2 | F) = 0.25	P(s2 | U) = 0.583

1. a. Construct a decision tree assuming that the company will first make the decision of whether to send the manuscript out for review and then make the decision to accept or reject the manuscript.
2. b. Analyze the decision tree to determine the optimal decision strategy for the publishing company.
3. c. If the manuscript review costs $5000, what is your recommendation?
4. d. W hat is the expected value of perfect information? What does this EVPI suggest for the company?