9. Electronics manufacturer SE must decide whether or not to invest in the devel

Question

9. Electronics manufacturer SE must decide whether or not to invest in the development of a new type of battery. If the development succeeds, the market for the battery may be large or small. If it doesn't succeed, the development efforts may or may not generate minor innovations that would offset some of the battery's development costs. The tree below summarizes the decision. The EMV of developing the new battery is $300,000. Based on EMV, SE should develop the battery. Given that development is successful, for what endpoint values for a large market does developing the battery have a lower EMV than not developing the battery? Less than $1.2 million Greater than $1.2 million Greater than $0.75 million None of the above Expected Profits Large Market 50% $2,700,000 EMV: $1,500,000 SuccesS 40% EMV: $300,000 Small Market 50% $300,000 Develop Valuable Innovations-$300,000 EMV:-$500,000 60% Failure 60% No Valuable Innovations-$800,000 4% Don't Develop S0

Explanation / Answer

At large market end point being 1.2 mn

EMV = 1.2*0.5+0.3*0.5 = 0.75mn

Overall EMV = 0.75*0.4+0.6*(-0.5) = 0

So we want EMV of developing < EMV of not developing

So end point will be less than 1.2mn (which will make the EMV of developing negative hence lower than not developing which is 0)

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