Problem: Let's make Hi-Tech Bikes (40 points)

Pawnee Bike Co. has successfully completed the first year of operations and they did end up selling 50,000 bikes in the first year and made $5 million in profit! Ron and Tom believe that they will sell another 50,000 bikes next year. However, now that they have the money they are thinking of introducing Hi-Tech Bikes. They are considering three new technologies that will require investment in equipment and development costs. They are planning to price the bikes so that they still get $1,000 profit per bike. However, they think they will sell a lot more bikes. However, they have no conclusive argument on estimating the true market potential. They came up with an optimistic and a pessimistic sale scenario but think that there is a 50-50 chance of either! They are particularly excited about the new technologies and think they can afford to invest in one of them. Table 2 summarizes the annual incremental cost of each technology and sales potential. While the cost estimates are pretty good the supplier has warned them that probability of cost overrun is 0.15.

Table 2: Hi-Tech Bikes Data

Technology Normal Cost (Millions/Year) Overrun Cost (Millions/Year) Optimistic Scale (Thousands) Pessimistic Scale (Thousands)

AI 1.0 1.2 75 55

AI + Solar 1.5 1.7 80 55

AI + Carbon Fiber 1.7 1.9 90 50

a. Use the decision tree tool to analyze their problem and propose what should they do? (20 points)

b. How will your recommendation in (a) will change if the AI + Solar cost estimates dropped to $0.8 and $ 1.0 million? (8 points)

c. What will be your decision if they could sell 55,000 bikes with the current con- figuration (no new investment) by spending additional $200,000 on advertising? (7 points)

d. Write a well formatted memo to Ron & Tom, summarizing your conclusion and recommendation on what should they do? (5 points)