A company is considering the development of a new product. The first step would

Question

A company is considering the development of a new product. The first step would be to do a feasibility study. If the outcome of the feasibility study is favorable, then the company would build a prototype. The probability that the feasibility study outcome will be favorable is estimated to be 65%. The probability that the prototype will be successful is estimated to be 70%. If the prototype is unsuccessful, then the company would sell it for an unspecified amount. a. How many possible scenarios are there? (In other words, how many possible outcomes where a NPV needs to be calculated?) ( Hint: build a probability tree) b. What is the probability the prototype will be built and be successful?

Explanation / Answer

Ans a) Different combinations are:

1) Favourable feasibility study + successful prototype

2) Favourable fesibility study + unsuccessful prototype

3) Unfavourable feasibility study + successful prototype

4) Unfavourable feasibility study + unsuccessful prototype

Ans b) Probablity that prototype will be built and be successful = (.7 * .65 ) *100%

= 45.5%

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