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Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful only 0.50. Furthermore, 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. 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 production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59-$5-$20-$34 million. Branch probabilities are also shown for the chance events. What is the expected value at node 4? Start R&D Project ($5 million) 0 Do Not Start the R&D Project O $25 million O$20 million O $30 million O Cannot be determined Successful 0.5 Not Successful 0.5 Building Facility ($20 million) Sell Rights Profit ($ millions) High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 34 20 10 20 0

Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful only 0.50. Furthermore, 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. 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 production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59-$5-$20-$34 million. Branch probabilities are also shown for the chance events. What is the expected value at node 4? Start R&D Project ($5 million) 0 Do Not Start the R&D Project O $25 million O$20 million O $30 million O Cannot be determined Successful 0.5 Not Successful 0.5 Building Facility ($20 million) Sell Rights Profit ($ millions) High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 34 20 10 20 0

Practical Management Science
Practical Management Science
6th Edition
ISBN:9781337406659
Author:WINSTON, Wayne L.
Publisher:WINSTON, Wayne L.
Chapter9: Decision Making Under Uncertainty
Section: Chapter Questions
Problem 46P
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Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, 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. 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 production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59-$5-$20-$34 million. Branch probabilities are also shown for the chance events. What is the expected value at node 4? Start R&D Project ($5 million) Do Not Start the R&D Project O $25 million O $20 million O $30 million O Cannot be determined Successful 0.5 Not Successful 0.5 Building Facility ($20 million) 3 Sell Rights Profit ($ millions) High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 34 20 10 20 -5 0
Transcribed Image Text:Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, 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. 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 production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59-$5-$20-$34 million. Branch probabilities are also shown for the chance events. What is the expected value at node 4? Start R&D Project ($5 million) Do Not Start the R&D Project O $25 million O $20 million O $30 million O Cannot be determined Successful 0.5 Not Successful 0.5 Building Facility ($20 million) 3 Sell Rights Profit ($ millions) High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 34 20 10 20 -5 0
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