Best Buy USA can engage a marketing firm, Market Research, Inc. (MRI), to do a market study
Question:
Best Buy USA can engage a marketing firm, Market Research, Inc. (MRI), to do a market study and a competitor analysis. However, this marketing firm, like all other marketing firms, is not perfect and this one is notoriously optimistic. In general, all marketing firms overestimate market conditions; it is estimated that 30% of all market studies overestimate demand, while only 10% of the time demand is underestimated. For this particular firm, if the economic prospects are actually low, the probability that MRI predicts average demand is 70% and high demand is 30% (probability of predicting low demand is 0). If the actual economic prospects are average, the probability that MRI predicts high demand is 65% and low demand is 0% (35% probability of accurately predicting average demand). If the actual economic prospects are high, there is no chance that the market study will forecast low or average demand. If Best Buy USA engages MRI to conduct the market study, the results of the research will be presented in one month. Best Buy USA will have to make the final decision two weeks later and the new store (if the investment is favorable) will probably be ready to open in less than one year from now.
4. What is the value of this imperfect information, that is, what is the value of the market study to be conducted by MRI? Would you pay $10M to MRI for this market research study?
a) Construct the error table for this marketing firm.
b) Calculate the probability that the marketing firm will predict next month that the demand for this facility in the future will be low. And average demand. And high demand.
c) Calculate the conditional probabilities (your confidence level) that the future demand will be low, average, and high demand in the case the marketing firm predicts low demand. Calculate the same conditional probabilities if the prediction of demand is average and high.
d) After MRI presents the results of their market study, BEST BUY will decide to build either a small, a medium or a large facility. For the case when the marketing firm predicts low demand, calculate the expected value of building the small, the medium, or the large facility given the revised probabilities calculated in c). Calculate the same expected values for the cases when demand prediction is average and high.
e) Calculate the expected value of this investment in the case when Best BUY hire the marketing firm MRI to conduct this imperfect market study. Calculate the expected value of imperfect information. Is the market study worth $10M?
f) What are the actual net cash flows possible if the BEST BUY engages MRI to conduct this market study?
g) Draw a decision tree depicting the decision to hire MRI or not, the possible demand predictions that MRI may present to you in one month, the different size stores that BEST BUY has the option to build, and the possible demand levels for this BEST BUY location that will develop in the future. Insert all probabilities and expected values calculated in the previous steps.
