Decision Analysis:

Your firm makes all decisions based on EMV.

The firm is considering entering the business of producing and selling widgets. The profitability of this venture will depend on the level of demand for the product.

Your marketing professionals tell you that there are two levels of demand that could prevail - High and Low. The outcome at these two levels are a profit of $3,000,000 if demand is high and a loss of $4,000,000 if demand is low. The two levels of demand are equally likely (probabilities of 0.5 each).

As CEO, you must decide is you should to enter the industry.

a. Model the above-described situation as a decision-tree. Using the EMV criterion, solve the tree and lay out a recommendation for the company? SHOW YOUR WORK.

My recommendation is that the company should:

ENTER or DO NOT ENTER (Circle One)

If we follow the recommendation above, EMV for the optimal decision is _________________

b. Suppose that you were able to hire a MadMen LLC to develop advertising campaign for the project. They guarantee that the campaign will increase the probability of "High Demand" to 0.7 (a 70% chance). Obviously "Low Demand will have a probability of 0.3

MadMen LLC will charge you $500,000 to conduct this campaign. The cost will reduce the profits from part (a) by that amount (reduced by $500,000)

Do you recommend that MadMen LLC be hired? SHOW YOUR WORK. YES, hire them or NO, Do not hire them

(Circle One)

If we follow the recommendation above, EMV for the optimal decision is _________________

c. MadMan LLC announces that they may increase the price they charge you for the advertising campaign What is the most that you would pay for the advertising campaign? SHOW YOUR WORK.

The maximum that I would pay is ______________________________

d. Right before you make a decision on hiring MadMan LLC, you learn that they have gone out of business and thus cannot do the advertising campaign. Further, there are no other advertising firms available (so, you are right back where you were in [a]).

However, you learn that there is a marketing research firm (DataClick) that that can conduct research and tell you with perfect certainty (probability of 100%) whether the level of demand will be high or low - before decide about entering the market.

What is the most that you would pay DataClick to answer that question? SHOW YOUR WORK.

I would pay any amount up to ____________________________

e. Outline the conditions under which you may use the EMV criterion. In other words, how can we defend EMV as the appropriate decision rule.