The Casti engineering company manufactures specialized components for agricultural machinery. The moving parts of one of these components need to be protected by applying a waterproof seal to its surface. Recently two new technologies have become available, which it is thought could rep lace the existing method and yield cost savings which would give Casti a significant advantage over competitors. The company now has to decide which technology, if any, it should develop (resource constraints mean that only one technology can be developed at any one time). The first technology is a patented method called KVG electro sealing. It is thought that there is a 0.8 probability that this technology could successfully be applied to the sealing process. The cost of developingthistechnologyisestimatedtobe$8millionandasuccessfuldevelopmentwouldleadtogross savings (i.e. savings before development costs have been taken into account) of $19 million with a probability of 0.1, $12 million with a probability of 0.5 and $9 million with a probability of 0.4. If the process could not be made to work successfully then the company would abandon the project and continue with the existing method of sealing. The second technology would involve dipping the components in a solution of TCX. Developing t his technology would cost an estimated $2 million, but it is thought that there is only a 0.65 probability that the process could be designed to meet EC pollution standards. If pollution standards can be met thenthe process will lead to gross savings esti mated to be worth $8 million. If the standards cannot be met then the company would have three options. Either it could abandon the entire project, or it could attempt to modify the method or it could switch its resources in an attempt to develop the KVG e lectro- sealing instead. Modifying the TCX dipping procedure would be likely to cost a further $2 million and it is thought that there would be a 50:50 chance that the modification would succeed. In the event of modification failing to meet the pollution standards the entire project would be abandoned. Assuming that Casti's objective is to maximize expected net savings (i.e. gross savings minus development costs) determine the policy that the company should pursue (for simplicity you should ignore time preferences for money).

Decision Tree Exercise The Casti engineering company manufactures specialized components for agricultural machinery. The moving parts of one of these components need to be protected by applying a waterproof seal to its surface. Recently two new technologies have become available, which it is thought could replace the existing method and yield cost savings which would give Casti a significant advantage over competitors. The company now has to decide which technology, if any, it should develop (resource constraints mean that only one technology can be developed at any one time). The first technology is a patented method called KVG electro sealing. It is thought that there is a 0.8 probability that this technology could successfully be applied to the sealing process. The cost of developing this technology is estimated to be $8 million and a successful development wouldleadtogross savings (i.e. savings before development costs have been taken into account) of $19 million with a probability of 0.1, $12 million with a probability of 0.5 and $9 million with a probability of 0.4. If the process could not be made to work successfully then the company would abandon the project and continue with the existing method of sealing. The second technology would involve dipping the components in a solution of TCX. Developing this technology would cost an estimated $2 million, but it is thought that there is only a 0.65 probability that the process could be designed to meet EC pollution standards. If pollution standards can be met thenthe process will lead to gross savings estimated to be worth $8 million. If the standards cannot be met then the company would have three options. Either it could abandon the entire project, or it could attempt to modify the method or it could switch its resources in an attempt to develop the KVG electro- sealing instead. Modifying the TCX dipping procedure would be likely to cost a further $2 million and it is thought that there would be a 50:50 chance that the modification would succeed. In the event of modification failing to meet the pollution standards the entire project would be abandoned. Assuming that Casti's objective is to maximize expected net savings (i.e. gross savings minus development costs) determine the policy that the company should pursue (for simplicity you should ignore time preferences for money)