Decision trees and product design. Kiwi business “out of This World Electronics (OOTWE)” is exploring the possibility of producing and marketing a new CPU (Central Processing Unit). To achieve this, OOTWE has identified the need to either invest in the latest software to achieve highly detailed design drawings, or contract the services of a proven specialist engineer who has the necessary software to perform the drawings themselves. Or do nothing. There are therefore 3 x potential courses of action for you to decide between.
Your task is to rationalize there 3 x options and determine which of the three options makes most commercial sense to you to proceed with; and to do this you need to construct a decision tree which has the following assumptions underlying it:
Assumption #1 : the probability of the target market receiving the contemplated new CPU favorably is thought to be 67%; whereas the probability of the target market not demonstrating a favorable response to the new CPU is thought to be 33%.
Assumption #2: it is predicted that the portion of the target market that is anticipated will receive the CPU favourably will buy 15,000 units during Year One providing that the unit price of the CPU is set at $17.50/ unit. However, it is also predicted that the portion of target customers who represent unfavorable acceptance of the CPU will buy 3,500 units during Year One at this same selling price.
Assumptions #3 : the software under consideration is commercialized - but only just; which means the supplier has set a relatively high market price for it ($25,000 for full license rights per annum).
Assumptions #4 : the cost of engaging a contracted Engineer to otherwise produce the required drawings is thought to be $45,000 per annum.
Assumptions #5: because of the design efficiencies inherent in the new software (i.e. the menu palette offers “drag and drop” options that its rivals can’t match), it is anticipated that the CPU unit manufacturing cost would reduce from $4.50/unit to $2.75/ unit id the new software is used.
Question :
After constructing the Decision Tree calculate the Expected Monetary Values (EMV) of proceeding to purchase the new software system versus the EMV involved in instead proceeding to engage the contracted engineer. Show all working/ calculation.
Based on EMV, which of the 3 options makes most commercial sense to proceed with?