Problem
Mark has just been fired as the College bookstore manager for setting prices too low (only 20 percent above suggested retail). He is considering opening a competing bookstore near the campus, and he has begun an analysis of the situation. There are two possible sites under consideration. One is relatively small, while the other is large. If he opens at Site 1 and the demand is good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at Site 2 and the demand is high, he will generate a profit of $80,000, but he will lose $30,000 if demand is low. He also has the option of not opening at either site. He believes that there is a 50 percent chance that demand will be high. A market research study will cost $5,000. The probability of a good demand given a favorable study is 0.8. The probability of a good demand given an unfavorable study is 0.1. There is a 60 percent chance that the study will be favorable.
1. Make the decision tree diagram and evaluate the options.
2. If the study is done and the results are favorable, what would Mark's expected profit be?
3. What is the maximum amount Mark should be willing to pay for this study?