DefTech, a private company, is considering whether or not to bid on a U.S. Department of Defense
Question:
DefTech, a private company, is considering whether or not to bid on a U.S. Department of Defense (USDOD) project. The project is for the development of a new, more effective stealth technology that will prevent any detection of U.S. military aircraft. DefTech will need to invest $180 million up-front to develop the technology. While preliminary contracts suggest that the USDOD will purchase the technology from DefTech for $350 million.
However, the contract will take many years to complete and DefTech executives are worried about what will happen if there are future budget cuts. Once they are part-way through development, DefTech fears that USDOD leadership may renegotiate the contract with them, offering to pay them only $150 million.
If this happens, DefTech could sue the USDOD for breach of contract and probably win some of the money back, but they would also damage their relationship, causing them to win many fewer USDOD contracts in the future.
Suppose that the payoffs from all of the various situations are as described in the following game tree. (The first number listed in each payoff pair is DefTech’s, the second is the USDOD payoff.)
What is the equilibrium outcome in this game?
Group of answer choices
DefTech invests, USDOD reduces price, DefTech sues
DefTech invests, USDOD reduces price, DefTech doesn’t sue
DefTech invests, USDOD keeps price
DefTech doesn’t invest
There is no equilibrium
Financial Management Principles and Applications
ISBN: 978-0133423822
12th edition
Authors: Sheridan Titman, Arthur Keown, John Martin