You believe that there is a 20% chance that the market for the Cycle Right helmet is excellent. The chance of a good market is 40%. You also know that the market for your helmet could be only average (30% chance) or even poor (10% chance).

 

Unique Products Inc., that is willing to be a partner in developing the Cycle Right helmets and sharing any profits. You determined if the market is excellent, you would net $5,000 per month. With a good market, you would net $2,000. An average market would result in a loss of $2,000, and a poor market would mean you would be out $5,000 per month. 

 

Another option is to have Innovators LTD (ILTD) make the helmets. The company had extensive experience in making ski and bicycle helmets. Unique Products would then take the helmets made by ILTD and do the rest. In this scenario, you have a greater risk. You estimate that you could lose $10,000 per month in a poor market or $4,000 in an average market. A good market for Cycle Right would result in $6,000 profit, and an excellent market would mean a $12,000 profit per month. 

A third option is to use TechComm (TC), a radio company in Melbourne, Florida. TechComm has extensive experience in making military radios; they could also make helmets, and Unique Products could do the rest of production and distribution. Again, you would be taking on greater risk. A poor market would mean a $15,000 loss per month, and an average market would mean a $10,000 loss. A good market would result in a net profit of $7,000 and an excellent market would return $13,000 per month.
 

You could also have Star Cellular (SC) develop the cell phones. They would make the phones and you would then have Unique do the rest of the production and distribution. Because the cell phone is the most expensive component of the helmet, you could lose $30,000 per month in a poor market. You could lose $20,000 in an average market. If the market was good or excellent, you would see a net profit of $10,000 or $30,000 per month, respectively.
 

Your final option is to forget about Unique Products entirely. You could use Innovators LTD to make the helmets, Star Cellular to make the phones, and TechComm to make the AM/FM stereo radios. You could then hire some friends to assemble everything and market the finished Cycle Right helmets. With this final alternative, you could realize a net profit of $55,000 a month in an excellent market. Even if the market was just good, you would net $20,000. An average market, however, would mean a loss of $35,000. If the market is poor, you would lose $60,000 per month. 

 

1. What do you recommend?
2. Compute the expected value of perfect information.

Answer rating: 100% (QA)

To determine the best course of action we can compute the expected value for each option and then compare them The expected value is calculated by mul... View the full answer