The Innovation company is considering the introduction of a new product that is believed to have a 50-50 chance of being successful. One option is to try out the product in a test market, at an estimated cost of $2 million, before making the introduction decision. Past experience shows that ultimately successful products are approved in the test market 80 percent of the time, whereas ultimately unsuccessful products are approved in the test market only 25 percent of the time. If the product is successful, the net profit for the Innovation company will be $40 million; if unsuccessful, there will be a net loss of $15 million for the company.
Discarding the test market option, draw and upload a decision tree and apply Bayes’ rule to determine whether or not the Innovation company should introduce the product. (NOTE: You can draw the tree using software (e.g., Microsoft Paint, PowerPoint) or draw in on a piece of paper and take a picture.
What is the expected value of perfect information in this situation?
Assuming that the test market approves the product, what is the probability that the product will ultimately be successful?
Draw and solve the decision tree that includes trying the product in a test market.
Should the Innovation company try the product in a test market? Why, why not?