The financial director of Spinney Electronics is considering the national launch of a new washing machine. The potential sales of the product during its lifetime are classified as being either high, medium, or low and the net present value of the machine sales under each of these three conditions is estimated to be sh50 million, sh10million, and sh20 million respectively. The marketing director estimates that there is a 0.4 probability that sales will be high, a 0.25 probability that they will be medium, and a 0.35 probability that they will be low. 

Required: 

a) Assuming the company’s objective is to maximize expected NPV, determine whether or not the new product should be launched. 

b) Explain the meaning of ‘the expected value of perfect information. Find the expected value of perfect information for this situation. 

c) The financial director also has an alternative solution. Instead of proceeding directly with a full national launch, the company could test the market for the washing machine in their Midlands sales region. This would delay the national launch, and this delay, together with other outlays associated with testing the market, would lead to costs having a net present value of sh0.25 million. The test marketing in the Midlands sales region would yield information indicating whether the national launch is likely to be successful or unsuccessful. The following table shows the reliability of each of the possible indications. Actual national sales Probability High Medium Low Test marketing indication Successful 0.6 0.6 0.15 0.25 Unsuccessful launch 0.4 0.1 0.4 0.5 For example If the market indicates a successful launch, then the probability of low sales will be 0.25. 

Also prior to the test market, it is thought that the test market has a probability of 0.6 of indicating a successful launch and of 0.4 for an unsuccessful launch. 

i. Represent this information in a decision tree and calculate the value of this imperfect information. 

ii. Give advice to the financial director as to whether or not the company should test the market in their Midlands region. In your advice, explain why this method of analysis should not be relied upon entirely when making appropriate decision.

Answer rating: 100% (QA)

In decision theory the expected value of perfect information EVPI is the price that one would be willing to pay in order to gain access to perfect information1 A common discipline that uses the EVPI c... View the full answer