Decision Making

Decision Analysis Exercises

Question 1

Bio-Futures is a well-established biotechnology company with annual profit approaching €20 million. Trevor Jones, the CEO of the company, faces a difficult problem. He needs to decide whether to carry on with the launch of a new biosensor that his company has been developing for the last two years. More than €0.5 million has already been spent on research and development costs.

Trevor is unsure about the demand for this product. If things work out well (high demand) he estimates that the biosensor can generate cashflows with an NPV of €800,000. Under medium demand he estimates an NPV of €150,000. The problem is that if demand turns out to be low, the launch of the biosensor can result in a negative NPV of €600,000, due to the high production costs involved.

His marketing team advised him that the probabilities of high, medium or low demand are 0.2, 0.4 and 0.4 respectively.

a) Draw a simple decision tree to decide whether or not Trevor should launch the new product.

The marketing team pointed out to Trevor that they could employ Bio-Marketing Inc., a market research company that specialises in biotechnology products. Bio-Marketing could conduct market research to establish the market potential of this biosensor.

b) What is the maximum amount that Bio-Futures should pay Bio-Marketing to get information about demand for the biosensor?

Question 2

Voice Recognition Technologies, Inc. (VRT) is investigating the possibility of developing software that can be incorporated into standard word processors for the purpose of voice recognition, making it possible to input text by dictating it instead of having to type it. Based on VRT’s experience with previous software development projects, VRT estimates that the total cost to develop a prototype is €200,000. If the prototype is a success, VRT will be able to sell the rights to the software to a developer of word processors. A “moderate...