Your firm is considering development of a new technology to produce specialized widgets. If you invest in the technology, it will require an outlay of $3.6 million. It is unclear that this investment will necessarily result in a new technology being developed. In fact, your engineers estimate that there is a 50% probability that the technology development will be successful. If the technology cannot be successfully developed, then the entire $3.6 million in development cost will be lost. If the technology is successfully developed, you may either use the technology to produce and sell widgets yourself or you may license the technology to another company for $7.2 million. This $7.2 million is a profit that included the $3.6 million in development cost (i.e. you "gross" $10.8 million, net $7.2 million) . You cannot both produce the product and license the technology. If you produce and sell the widgets yourself, the profitability will depend on the level of demand for the produce. Your marketing professionals tell you that there are two levels of demand that could prevail - High and Low. The profits at these two levels are $6 million and $2 million respectively. The probabilities of these two levels of demand are 0.7 and 0.3, respectively. These profits include the development cost of the technology.

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?

My recommendation is that the company should: ________________________________________________________________

The EMV for the optimal decision is _________________

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

c. Suppose that you were able to hire a company to estimate the market demand for the project with perfect certainty (i.e., they could tell you with perfect certainty if the level of demand would be high or low). If they company were to give you that information for free, would it change your decision? If so, what is the most you would pay for that information? SHOW YOUR WORK (INCLUDING HOW DECISION TREE WOULD CHANGE) How it would change decision is __________________________________ Most I would pay is ________________________