Problem 4-17 Hemmingway. Inc.. is considering a $5 million research and development (RM?) project. Prot projections appear promising, but Hemmingway's president is concerned because the probability that the RM) project will be successful is oniv 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a (bit of $20 miilion in order to manufacture the product. It the facility is built, uncertainty remains about the demand and thus uncertainty about the prot that will be realized. Another option is that if the R&D project is successful, the company couid sell the rights to the product for an estimated $25 million. Under this option, the company would not build the 520 million production facility. FIGURE 4.16 DECISION TREE FOR HEMMINGWAY. INC. Prot IS millions) High Demand 34 0.5 Building Facility ($20 million) Medium Demand 20 0.3 Low Demand [0 Successful Stan R&D Project ($5 million) Sail Righls 20 Not Successful _5 Do Not Start the R&D Project The decision tree is shown in Figure 4.16. The prot projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the READ project ($5 miilion] and the cost of the production facility [520 million] Show the prot of this outcome to be $59 55 $20 = $34 rn n. Branch probabilities are also shown for the chance events. a. Analyze the decision tree to determine whether the company ahouid undertake the RED project. If it does, and if the R&D project is successful, what should the company do? What is the expected vaiue of your strategy? Expected value = is E M b. What must the selling price be for the company to consider selling the rights to the product? Payoff for sell rights would have to be 5!; |:l M or more. In order to recover the $5M RED cost, the seiling price would have to be 3; |:l M or more. c. Develop a risk prole for the optimal strategy. If required, round your answers to two decimal piaces. Assn ted Poss le Prof Proha ty _I:I __I Total Probabiiity_