Dear Tutor,

Can you help me with the following question:

A manufacturer of high-tech computing equipment must decide whether or not to continue development of a new promising technology. If a patent for the technology is awarded, the company must decide whether to license the technology or to produce and market it in house, in which case the ultimate payoffs would depend on the demand for the product. The following decision tree summarizes the situation. Note that the net payoffs at the end of the tree take the various inflows and outflows of money represented at various nodes into account. For example, continuing the development costs $2 Million, licensing the technology would generate $25 Million such that the net at the end of the top path is $23 Million.

What is the maximum amount of money a risk-neutral decision maker should pay to get more information about whether or not the patent will be awarded?

License $23M Patent Technology Awarded $25M Continue P = 0.7 Demand High $43M Development p = 0.25 $55M -$2M Develop Production and Marketing to Sell Demand Medium Product Directly $21M p = 0.55 $33M -$10M No Patent -$2M Demand Low P = 0.3 p = 0.20 $15M $3M Stop Development $0