1. A company has prepared a design for a new product which it can either sale for K100 000 or develop into a marketable product at a cost of K150 000. The chances of success if the product is developed are 0.7. If this attempt fails the design can only be sold at K20 000. If the attempt succeeds the business has the choice of either selling the design and developed product for K180 000 or marketing the product. If the product is marketed then there is a 0.6 probability that the product will generate a cash inflow of K800 000 and a 0.4 probability that it will generate a cash outflow of (K100 000). Both figures exclude items previously mentioned.

Draw a decision tree and advise management as to their best course of action.

a). Assume that the cost of capital is 10 % and it took one year to develop the designs and a further year before the contribution was received, what would be the position now?

b). Supposing there is a small change in the estimated probabilities of success and failure in the product development phase from 0.7: 0.3 to 0.6: 0.4 what would be the change in expected value?