A restaurant chain has been working on a new line of seasonal deserts. The company recently completed

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Question:

A restaurant chain has been working on a new line of seasonal deserts. The company recently completed the product design effort. The COO now has to decide among 3 alternatives:

1- Scrap the product,

2- Launch the product system wide, or

3- Conduct a market test.

-->If the company scraps the product the payoff is $0. If they decide to launch the product system wide, the company will incur a $2,250,000 rollout cost. Marketing believes that acceptance could be high with a probability of 60%, and low with a probability of 40%. Profits (not including rollout costs) are estimated at $5,000,000 if acceptance is high, or $1,000,000 if acceptance is low.

-->If the company decides to conduct a market test, the study will cost $350,000. The company believes there is a 50% chance the analysis results will be positive. Once the results of the study are received, the company will need to decide whether to launch or scrap the product.

If the market test results are positive and the company decides to launch, the company will incur the $2,250,000 rollout costs. In this context, the probability the product will experience high acceptance and earn $5,000,000 is estimated at 90%, while the probability the product will earn $1,000,000 is 10%.

-->If, on the other hand, the analysis results are negative and the company decides to launch (incurring the rollout costs), the probability the product will experience high acceptance and earn $5,000,000 is estimated at 10%, while the probability the product will earn $1,000,000 is 90%.

You must use Excel to develop a decision tree for this problem. Next, answer the following questions using your tree diagram.

• Report the expected values of the three alternatives (i.e., scrap the product, launch the product system-wide, and conduct a market test).

- 2 - • What should the company ultimately do: Scrap, launch or test the product?

• If the company decided to conduct a market test and the test results were positive: what would the terminal payoff of scrapping the product be?

• If the company decided to conduct a market test and the test results were positive: what would the expected value of launching the product be?

• Assume the company decided to conduct a market test and the test results were positive: what would the terminal payoff be if the company experienced high acceptance after launching the product?

• Assume the company decided to conduct a market test: what should the company do if the study results were positive?