C&A Health Club currently has 500 members paying an annual membership fee of $120. It is considering adding a swimming pool at a cost of $10,000. The addition of the pool will increase its variable costs from $50 to $70 per members. C&A can test market the demand for a swimming pool or bypass the test market and add the pool right away.
If the pool is a success, C&A will be able to attract an additional 300 members to its club and at the same time increases its annual membership fee by $30 per member. However, if it is a failure, C&A will not expect to see any increase in membership nor fee. C&A believes the probability of success for the pool is 50% if the pool is added without the test market.
The other option is to conduct a test market and then decide whether or not to add the pool. The cost of the test market is $5,000. The probability of a positive test market result is estimated to be 60%. C&A will add the pool only if the test market result is positive. The probability of success with a positive test market result increases to 80%.
What decision should C&A make, and what is the expected value of that decision?
1) Add the pool, $54,000
2) No market test, $34,500
3) Do the market test then add the pool, $49,000
4) Do the market test, $36,720
5) No pool, $34,500