Mega Studios is thinking of producing a megafilm which could be a megahit or a megaflop. Profit is uncertain for two reasons: (1) the cost of producing the film may be low or high, and (2) the market reception for the film may be strong or weak. There is a 0.6 chance of low costs (and a 0.4 chance of high costs). The probability of strong demand is 0.5 (the probability of weak demand is 0.5). The studio’s profits (in millions of dollars) for the four possible outcomes are shown in the table:     demand     strong weak cost low 80 10 high 0 -70   a) Should the studio produce the film? Justify your answer using expected profits. b) The studio is concerned that the film’s director might let production costs get out of control. Thus, the studio insists on a clause in the production contract giving it the right to terminate the project after the first $30 million is spent. By this time, the studio will know for certain whether total production costs are going to be low (i.e. under control) or high (out of control). What is the studio’s best action in case of such a production contract (i.e. determine whether and when the studio should terminate the project)? Find expected profits of the studio. (Use a decision tree)

Mega Studios is thinking of producing a megafilm which could be a megahit or a megaflop. Profit is uncertain for two reasons: (1) the cost of producing the film may be low or high, and (2) the market reception for the film may be strong or weak. There is a 0.6 chance of low costs (and a 0.4 chance of high costs). The probability of strong demand is 0.5 (the probability of weak demand is 0.5). The studio’s profits (in millions of dollars) for the four possible outcomes are shown in the table:

demand

strong

weak

cost

low

80

10

high

0

-70

a) Should the studio produce the film? Justify your answer using expected profits.

b) The studio is concerned that the film’s director might let production costs get out of control. Thus, the studio insists on a clause in the production contract giving it the right to terminate the project after the first $30 million is spent. By this time, the studio will know for certain whether total production costs are going to be low (i.e. under control) or high (out of control). What is the studio’s best action in case of such a production contract (i.e. determine whether and when the studio should terminate the project)? Find expected profits of the studio.

(Use a decision tree)