You are responsible for the R&D Department in your company. You must decide weather to spend $2 million now (beginning of Year 1) to continue with a particular research project. The success of the project (as measured by obtaining a patent) is not assured. At this point, the chance of succeeding is judged to be 70%.

If the project is successful, you will be able to license the patent in one year (Year 2) for a total cash inflow of $25 million which is to be distributed to your department as $5 million per year starting in Year 3 for 5 years.

On the other hand, you also have the option to commercialize the patent (i.e., invest in making then selling the product based on the patent)., you will need to invest $5 million in each of Years 3 and 4. If you do that, you profit will be $11 million, $6.6 million or $3 million each year in the next five years (Year 5-9) if the demand is high, medium or low. The probability for the high, medium and low level of demand for your product is estimated to be 25%, 55% and 20% respectively.

a. Draw out the structure of the decision tree that can help you make the above decisions (8 points)

b. Calculate and fill out all the numbers to complete the decision tree, please show the calculations of the numbers when needed. You may use a discount rate of 8% to roll back future cash flow into the present (8 points)

c. Calculate EMV and indicate your optimal decision (4 points)