A company has formalized a new-product concept and must now decide whether to pr
ID: 3367585 • Letter: A
Question
A company has formalized a new-product concept and must now decide whether to provide for long-range production capacity in its five-year plan. The company has three opportunities for profiting from the new product: sell the idea outright now to another company, lease the concept for a royalty, or develop the product in-house. If the concept is sold outright, it will bring $1,500,000. A consulting firm has surveyed the potential markets for the idea. If the concept is leased for royalty, two companies have submitted proposals and this information applies:
Size of Market
Probability
Payoffs
COMPANY A
Large
.5
$2,800,000
Marginal
.5
2,200,000
COMPANY B
Large
.5
2,600,000
Marginal
.5
2,300,000
If the company develops the concept into a new product, it can sell the rights to the product. If this alternative is selected, this information applies:
Size of Market
Probability
Payoffs
Large
.5
$2,500,000
Marginal
.5
2,200,000
If the company develops the new product and then produces and markets it, this information applies:
Size of Market
Probability
Payoffs
Large
.5
$3,000,000
Marginal
.5
1,800,000
Use a decision tree analysis and recommend a course of action for this new product idea. Show the payoffs expected for each alternative.
Size of Market
Probability
Payoffs
COMPANY A
Large
.5
$2,800,000
Marginal
.5
2,200,000
COMPANY B
Large
.5
2,600,000
Marginal
.5
2,300,000
Explanation / Answer
General Information :
Expected pay off = p1*(payment1) + p2*(payment2)
If leased to company A :
Expected pay off : 0.5*2,800,000+0.5*2,200,000 = 2,500,000
If leased to company B:
Expected pay off : 0.5*2,600,000+0.5*2,300,000 = 2,450,000
If the company develops the concept into a new product, it can sell the rights to the product, if this alternative is selected then
Expected Pay off : 0.5*2,500,000 +0.5*2,200,000 = 2,350,000
If the company develops the new product and then produces and markets it, this information applies:
Expected Payoff : 0.5*3,000,000 + 0.5*1,800,000 = 2,400,000
If sold we get 1,500,000
We go for the option we get the highest expected pay off: which is leasing for Company A.
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