Question 4: Star Ltd sells electronic equipment and it is about to launch a new product in to the market. It needs to prepare its budget for the coming year and is trying to decide whether to launch the product at a price of 40 or 50 per unit. The following information has been obtained from market research; Price per unit 40 Sales volume Price per unit 50 Sales volume Probability Probability 240,000 216,000 220,000 200,000 260,000 185,000 0.3 0.5 0.4 0.2 0.3 0.3 Additional information: a. Variable production costs would be 18 per unit for production up to and including 200,000 units each year. However, if production exceeds 200,000 units each year, the variable production cost per week would fall to 16 for all units produced. b. Advertising costs would be 900,000 per annum at a selling price of 40 and 970,000 per annum at a selling price of 50. c. Fixed production costs would be 450,000 per annum. Required: 1) Calculate each of the six possible profit outcomes, which could arise for Star Ltd in the coming year. (06 marks) 2) Calculate the expected value of profit for each of the price option and recommend, on this basis, which option Star Ltd should choose. (04 marks) 3) Briefly discuss the limitations of using expected values in decision-making, (02 marks) 4) Briefly explain the maximin decision rule and identify which price should be chosen by the management if they use this rule to decide which price should be charged. (04 marks) 5) Briefly explain the maximax' decision rule and identify which price should be chosen by the management if they use this rule to decide which price should be charged. (04 marks) 6) Discuss the factors which may give rise to uncertainty when setting budgets. (05 marks) Appendix PRESENT VALUE TABLE Present value of S1, that is (1+r) where r = interest rate: n= number of periods until payment or receipt Interest rates 02 Periods In) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 15 0.960 0.980 0.971 0961 0.951 0.942 0.933 0.923 0.914 0.905 0898 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.829 0.820 2 0.980 0.961 0942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0 804 0.788 0.773 0.750 0.743 0.728 0.714 0.700 0.686 0.873 3% 0.971 0.943 0915 0.888 0.863 0.837 0813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0605 0.587 0570 0554 0.962 0.925 0.889 0855 0.822 0.790 0.780 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0456 5% 0.962 0.907 0.864 0.823 0.784 0746 0.711 0.677 0,645 0.614 0.585 0.557 0.530 0.505 0.481 0.458 0436 0416 0.396 0 377 69 0.943 0.890 0 840 0.792 0.747 0705 0.665 0.627 0592 0558 0.527 0.497 0.469 0.442 0.417 0.394 0.371 0350 0331 0.312 79 0.935 0.873 0.816 0.763 0.713 0.666 0523 0.582 0.544 0508 0 475 0.444 0.415 0388 0.362 0.339 0317 0.296 0.277 0 250 8% 0.926 0.857 0.794 0.735 0.681 0.630 0583 0.540 0 500 0463 0429 0.397 0.368 0.340 0315 0.292 0270 0.250 0.232 0215 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178 10% 0.909 0.826 0751 0683 0.621 0.564 0.513 0467 0.424 0.386 0350 0.319 0 290 0.263 0.239 0.218 0.158 0 130 0.164 0.149