Hemmingway, Inc., is considering a $9 million research anddevelopment (R&D) project. Profit projections appear promising,but Hemmingway's president is concerned because the probabilitythat the R&D project will be successful is only 0.50.Furthermore, the president knows that even if the project issuccessful, it will require that the company build a new productionfacility at a cost of $20 million in order to manufacture theproduct. If the facility is built, uncertainty remains about thedemand and thus uncertainty about the profit that will be realized.Another option is that if the R&D project is successful, thecompany could sell the rights to the product for an estimated $33million. Under this option, the company would not build the $20million production facility.
The decision tree is shown in Figure 13.18. The profitprojection for each outcome is shown at the end of the branches.For example, the revenue projection for the high demand outcome is$68 million. However, the cost of the R&D project ($9 million)and the cost of the production facility ($20 million) show theprofit of this outcome to be $68 − $9 − $20 = $39 million. Branchprobabilities are also shown for the chance events.
Yes, the company should start the R&D project and if it issuccessful, then the company should build the facility.Yes, thecompany should start the R&D project and if it is successful,then the company should not build the facility.No, the companyshould not undertake the R&D project.
- Problem 13 17 Algorithmic Hemmingway Inc Is Considering A 9 Million Research And Development R D Project Profit 1 (210.29 KiB) Viewed 8 times
- Problem 13 17 Algorithmic Hemmingway Inc Is Considering A 9 Million Research And Development R D Project Profit 2 (30.51 KiB) Viewed 8 times
a. Analyze the decision tree to determine whether the company should undertake the R&D project. If it does, and if the R&D project is successful, what should the company do? Yes, the company should start the R&D project and if it is successful, then the company should build the facility. Yes, the company should start the R&D project and if it is successful, then the company should not build the facility. No, the company should not undertake the R&D project. Expected value = $ b. What must the selling price be for the company to consider selling the rights to the product? If required, round your answers to 2 decimal places. Payoff for sell rights would have to be $ have to be $ M or more. M or more. In order to recover the $9M R&D cost, the selling price would
c. Develop a risk profile for the optimal strategy. If required, round your answers to two decimal places. Possible Profit $39M $21M $11M -$9M Associated Probability