1. What is the expected value of the project? 2. Simulate this project 1000 times and compute...

Question:

1. What is the expected value of the project?

2. Simulate this project 1000 times and compute the average profit over the 1000 replications. Plot a histogram of the outcomes of the 1000 replications.

3. How does the average of the simulation compare to the expected value you calculated? What are the managerial implications of this difference?

MINI CASE

Photstat Inc. is contemplating the formation of a project team to develop a new service. Briefly, the service would allow customers to order customized mouse pads over the Internet based on photographs or other artwork sent electronically to the firm. The company estimates that the price of the mouse pad will be between $10 and$15 per unit, with all prices in this range equally likely. Based on historical data, Photstat estimates that the total market size for these types of products in their first year follows a normal distribution with a mean of 100,000 units and a standard deviation of 10,000. Again, according to historical data, Photstat’s market share tends to be normally distributed with a mean of 30 percent and standard deviation of 3 percent. Market growth tends to follow a normal distribution growing an average of 10 percent per year with a standard deviation of 3 percent. Estimates from the equipment manufacturer selected to design and produce the required equipment indicate that the cost of the equipment is normally distributed with a mean of $500,000 and a standard deviation of 60,000. Historical data indicate there is a 10 percent chance that the equipment will last for only three years. Similarly, there is a 60 percent chance the equipment will last six years, a 20 percent chance it will last eight years, and a 10 percent chance the equipment will last 10 years. The variable costs of similar products were found to be normally distributed with a mean of$3 and a standard deviation of \$0.25. Finally, an economic analysis undertaken by the firm suggests that the rate of inflation in any given year is normally distributed with a mean of 3 percent and a standard deviation of 0.5 percent.

Distribution
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