Hemmingway, Inc., is considering starting a research and development (R&D) project at an initial cost of $5 million. Profit projections appear promising, but the company's president is concerned because the probability that the R&D project will be successful is only 0.5. Secondly, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facility is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized (0.5 chance of high demand, with a projected outcome of $59 million; 0.3 chance of medium demand, with a projected outcome of $45 million; 0.2 chance of low demand, with a projected outcome of $35 million). Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million facility.
a. Build a decision tree (DT) for this problem.
b. Analyze the DT to determine the optimal strategy for the company. What is the expected value of the optimal strategy?
c. What must be the selling price for the company to consider selling the rights to the product?
d. Develop a risk profile for the optimal strategy.