Problem
A company has already spent $80,000 developing a new product, and is now considering whether or not to market the product.
Tooling for production of the new product would cost $50,000.
If the product is produced and marketed, the company estimates that there is only one chance in four that the product would be successful. If successful, the net income would be $100,000 per year for 8 years.
If not successful, the company would lose $30,000 per year for 2 years, after which time the venture would be terminated. The minimum rate of return on the capital is 20% per year.
1. Draw a decision tree and determine the best alternative using the expected net present value criterion.
2. There is a market research group that can provide perfect information about the success or otherwise of the product at a cost of $20,000. Should the company engage the market research group? Your work should include a decision tree, relevant calculations and explanation to justify your answer.
Note: In your calculations for part (2) of the question, use the same probabilities for the outcomes of the market research as indicated above, i.e. one in four for success.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.