Question
Your company is planning to introduce a new online shopping service.To reduce risk, senior management propose developing the service in three stages: A market test
Your company is planning to introduce a new online shopping service.To reduce risk, senior management propose developing the service in three stages:
A market test for one year with a few customers at a cost of $1 million. The likelihood of success for this test is estimated to be 75%.
A introductory period of one year, if the market test is successful. During this test the most widely ordered products will be available through the service to a wider audience. This phase of the project is estimated to cost $2.5 million with have a 50% chance of success.
Full roll-out of the service at the end of the second year if the introductory period is successful. This phase is estimated to cost $15 million and is expected to start generating revenue only by the end of the third year.
There are 3 possible outcomes from the full roll out:
OutcomeProbabilityYear 4 RevenueYear 5 RevenueYear 6 RevenueYear 7 Revenue
Huge Success25%$12M$15M$18M$21M
Moderate Success50%$7M$9M$11M$13M
Failure25%-$3M-$4M-$5M-$6M
i) Construct a decision tree and list all the outcomes and cumulative probabilities (it may be easier to construct the tree in a different program and copy and paste into Excel)
ii) Assume all the values are present values. Should the company pursue this project based on the expected NPV?
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