Expected Monetary Value

During the planning phase of a project, we are often forced to make decisions under uncertainty. Quantification analysis tools like decision trees can assign values to these decisions and give us data to increase our confidence that we are making the right choices. Use thePMBOKand Prichard texts (see Prichard's Chapter 20 on EMV) to complete this assignment.

Assignment

• Draw a decision tree for the below problem. You may use Excel, custom software, or freehand.
• Which action should Mr. Hony take in order to maximize his expected profit?

Submit the decision tree and recommendation to the correct Dropbox by the date given in the course calendar.

Problem

Hony Pharmaceuticals is a manufacturer engaged in the development and marketing of new drugs. The chief research chemist at Hony, Dr. Bing, informed the president, Mr. Hony, that recent research results have indicated a possible breakthrough to a new drug with wide medical use. Dr. Bing urged an extensive research program to develop the new drug. He estimated that with expenditures of $100,000, the new drug could be developed at the end of a year's work. When queried by Mr. Hony, Dr. Bing stated the chances were excellent --approximately 90 percent-- that the research group could develop the drug.

Mr. Hony, worried about the sales prospects of a drug so costly to develop, talked to his marketing manager, Mr. Margin, who said that the market for the potential new drug depended upon the acceptance of the drug by the medical profession. Margin also stated that he had heard rumors that several other firms had been considering developing such a drug. If several firms developed competing drugs, they would have to split the market among them. Hony asked Margin to make future market estimates for different situations, including estimates of future profits. Margin made the estimates shown below:

Market Condition	Likelihood	Present Value of Profit
Large market potential	0.1	$500,000
Moderate market potential	0.6	250,000
Low market potential	0.3	80,000
	1.0

Margin pointed out that the profit figures did not include the costs of research and development or the cost of introducing the product, which would be around $50,000. This latter cost would be incurred only if the firm decided to enter the market after the drug was developed.

Mr. Hony was somewhat concerned about spending $100,000 for development of the drug in the face of such an uncertain market. He returned to Dr. Bing and asked whether there was some way to develop the drug more cheaply or to postpone development until the market position was clearer. Dr. Bing said that he would prefer his previous suggestion--an orderly research program costing $100,000--but that an alternate plan was indeed possible.

The alternate plan called for a low-level part plus $110,000 for the crash program. Dr. Bing did not think this program would change the chances of a successful product development. One advantage of this approach, Dr. Bing added, was that the question of whether the drug could be developed successfully would be known at the end of the eight-month period. The decision could then be made at the end of eight months on whether to undertake the crash program. When consulted, Mr. Margin stated that at the end of eight months he would be able to estimate the market potential fairly accurately.

Mr. Hony inquired about the possibility of waiting until other drugs were on the market and then developing a drug on the basis of a chemical analysis of the competitive drug. Dr. Bing said that this was indeed possible and that such a drug could be developed for $50,000. Mr. Margin was dubious of the value of such an approach. He said that the first drugs out usually got the greater share of the market. He estimated that returns would be only about 40 percent of those given in the table. In addition, he indicated that there was a good chance, say one out of three, that no equivalent competitive drug would be marketed--in which case Hony would have nothing upon which to develop a drug.

Given this is a rather complex scenario with multiple interpretations, here are a few clarifying tips:

• The first decision is whether to develop or wait. If the decision is made to develop, there are two options - full development or crash - if either of these successfully goes to market - the market options are a large, medium, or small market. Likewise, if the decision is made to wait for a copy drug, there is a similar path to the market.
• To further explore the crash path - if the crash path is successfully pursued and goes to market there would a $110,000 crash cost plus a $50,000 cost to go to market. You can assume that the same large, medium, small market options would apply as the full development.