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An analyst is reviewing a clients decision to introduce a new product to the

electronics market. The client, Eagle Electronics, is considering whether or not to

develop a new product to tap into the burgeoning Smart Blu-ray and DVD Player

market. Given the current market trends, Eagle Electronics is unsure whether to

develop and introduce the new product today (Period 0) or next year (Period 1).

If the Smart Blu-ray and DVD Player is successful, the present value of the payoff

(when the product is brought to market) is 20 million. If the Smart Blu-ray and DVD

Player fails, the present value of the payoff is 5 million. If the product goes directly

to market, there is a 65 per cent chance of success.

Alternatively, Eagle can delay the launch by one year and spend 2 million to test

market the Smart Blu-ray and DVD Player. Test marketing would allow the firm to

improve the product and increase the probability of success to 85 per cent. The

appropriate discount rate is 10 per cent.

Questions

(i) Draw a decision tree representing the decision problem facing the analyst.

(10 marks)

(ii) What is the optimal policy for the analyst to follow? Carefully explain your

answer by showing workings. (20 marks)

(iii)Describe the two factors that affect the value of an investment timing option?

(5 marks)