If you invest in the technology, it will require an outlay of $5.6 million . It is
Question:
If you invest in the technology, it will require an outlay of $5.6 million. It is unclear that this investment will necessarily result in a new technology being developed. In fact, your engineers estimate that there is a 50% probability that the technology development will be successful. If the technology cannot be successfully developed, then the entire $5.6 million in development cost will be lost.
If the technology is successfully developed, you may either use the technology to produce and sell widgets yourself or you may license the technology to another company for $9.8 million. This $9.8 million is the gross profit (you will need to subtract out the $5.6 million in development cost). You cannot both produce the product and license the technology.
If you produce and sell the widgets yourself, the profitability will depend on the level of demand for the produce. Your marketing professionals tell you that one of two levels of demand that will prevail - High and Low. The profits at these two levels are $6 million and $3 million respectively. The probabilities of these two levels of demand are 0.6 and 0.4, respectively. These profits are NET OF development cost of the technology.
(a)Model the above-described situation as a decision-tree. Using the EMV criterion, solve the tree and lay out a recommendation?
(b)Supposethatyouwereabletohireacompanytoestimatethemarketdemandfortheprojectwith perfect certainty (i.e., they could tell you with perfect certainty [probability of 100%] if the level of demand would be high or low). If they company were to give you that information for free, would it change your decision? If so, what is the most you would pay for that information?
Contemporary Financial Management
ISBN: 9780324289114
10th Edition
Authors: James R Mcguigan, R Charles Moyer, William J Kretlow