1. Calculate the expected monetary value (EMV) of both company actions. Which action should the company take?

2. What is the expected value of perfect information (EMVPI)? Should the research be conducted?

Conducting research is costly, and the costs must be weighed against the value of the information gathered. Consider a company faced with a competitor's price reduction. Should the company also reduce price in order to maintain market share, or should the company maintain its current price? The company has conducted some preliminary research showing the financial outcomes of each decision under two competitor responses: the competition maintains its price or the competition lowers its price further. The company feels pretty confident that the competitor cannot lower its price further and assigns that outcome a probability (p) of 0.7, which means the other outcome would have only a 30 percent chance of occurring (1 - p = 0.3). These outcomes are shown in the table below:

For example, if the company reduces its price and the competitor maintains its price, the company would realize $160,000, and so on. From this information, the expected monetary value (EMV) of each company action (reduce price or maintain price) can be determined using the following equation:
EMV = (p)(financial outomep) + (1 - p)(financial outcome(1 - p))
The company would select the action expected to deliver the greatest EMV. More information might be desirable, but is it worth the cost of acquiring it? One way to assess the value of additional information is to determine the expected value of perfect information (EMVPI), calculated using the following equation:
EMVPI = EMVcertainty - EMVbest alternative
where
EMVcertainty = (p)(highest financial outcomep) + (1 - p)(highest financial outcome(1 - p))
If the value of perfect information is more than the cost of conducting the research, then the research should be undertaken (that is, EMVPI > cost of research). However, if the value of the additional information is less than the cost of obtaining more information, the research should not be conducted.

Transcribed Image Text:

Competitive Response Maintain Price Company action Reduce Price Maintain Price Reduce Price (1-p)-0.3 S120.,000 S100,000 S160.,000 S180,000