For the estimation, the CEO starts with P(S), the prior probability of the new product?s success and
Question:
For the estimation, the CEO starts with P(S), the prior probability of the new product?s success and the track records of the consultant?s precious forecasts: Find the following.
P(F|S) = % favorable forecast for similar products proven successful in the market.
P(U|N) = % unfavorable forecast for similar products proven not successful in the market
A major use of decision tree analysis is to estimate the expected value of information. We will use the following simple example to illustrate the application process.
In this case, a CEO needs to decide whether to invest $5 million to improve an existing product, which is sure to yield a profit of $7 million, or to develop a new product, which will yield a profit of $15 million if successful or $0 if not successful. A consultant offers to conduct a market forecast for the new product for a fee of $0.5 million. Should the CEO hire the consultant and in which product should the CEO invest?
A 2-stage tree shown below describes the decision process: the first stage is to decide whether to acquire the information; the second stage is to decide which product to invest. For simplicity, we assume that the CEO is risk-neutral and wants to maximize the expected net profit.
Statistics for Business and Economics
ISBN: 978-0132930192
8th edition
Authors: Paul Newbold, William Carlson, Betty Thorne