Decision tree: Develop and launch a new product

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Business Finance

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the decision tree is provided , please check attachment

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A company is deciding whether to develop and launch a new product. Research and development costs are expected to be $300,000 and there is a 60% chance that the product launch will be successful, and a 40% chance that it will fail. 

If it is successful, the levels of expected revenue and the probability of each occurring have been estimated as follows, depending on whether the product popularity is high, medium or low: 

Probability        Revenue 

High: 0.25        $500,000 per year for two years

Medium: 0.45     $400,000 per year for two years

Low: 0.3             $300,000 per year for two years 

If it is a failure, there is a 0.55 probability that the research and development work can be sold for $60,000 and a 0.45 probability that it will be worth nothing at all. 

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A company is deciding whether to develop and launch a new product. Research and development costs are expected to be $300,000 and there is a 60% chance that the product launch will be successful, and a 40% chance that it will fail. If it is successful, the levels of expected revenue and the probability of each occurring have been estimated as follows, depending on whether the product popularity is high, medium or low: Probability High: 0.25 Medium: 0.45 Low: 0.3 Revenue $500,000 per year for two years $400,000 per year for two years $300,000 per year for two years If it is a failure, there is a 0.55 probability that the research and development work can be sold for $60,000 and a 0.45 probability that it will be worth nothing at all. 1. Construct a decision tree for this problem and answer this question that whether this company should develop and launch this new product. Please draw your decision tree in PrecisionTree, enter all given data, and analyze the problem over there to answer this question. Hint: Please enter all of the given data/parameters value in Excel cells; rather than writing their constant values, that you can refer to them to calculate necessary values for each branch of your decision tree. This will be needed in order to be able to conduct sensitivity analysis of different influencing factors in part “b”. 2. Provide a list (At LEAST 4) of influencing factors/parameters (e.g. revenue per year when product popularity is high) on the final decision to develop and launch the new product or not. 3. For your provided list in part b”, select 2 of those factors, conduct a one-way sensitivity analysis for each SEPARATELY, show your graphs, and describe the behavior you observe. 4. For your provided list in part “b”, which factor is the most influential one on the decision to develop and launch the product or not? Please support your answer by providing necessary graphs and explaining them. Only conduct one-way sensitivity analysis in this part. There are two contracts for the supply of certain materials that your company is considering to make an offer on: Contract 1 and Contract 2. Submitting an offer for each contract costs the company. It is $30,000 to submit an offer for Contract 1 and the cost of submitting an offer for Contract 2 is $15,000. These costs will have to be entirely recouped from the contract price. The risk, of course, is that if an offer is unsuccessful the company will make a loss. If the company’s submitted offer for Contract 1 is successful, the cost of supplying the above-stated materials is $18,000, and this cost is $10,000 if the submitted offer for Contract 2 is successful. For each contract, possible offer prices have been determined. In addition, subjective assessments have been made to estimate the probability of getting the contract with a particular offer price as shown below. Note here that the company can only submit one offer for one of the two contracts; i.e. either Contract 1 or Contract 2, and also cannot submit two offers (at different prices) for the same contract. Option Possible offer prices ($) Contract 1 130,000 0.25 115,000 0.85 95,000 0.20 80,000 0.75 Contract 2 Probability of getting contract 1. What do you suggest the company should do and why? Develop a decision tree to analyze this problem. Use PrecisionTree to develop you tree and to conduct your analysis. 2. What should the possible offer price value of $80,000 for Contract 2 change to that the company decides to make an offer for a different Contract than the one made in part “a”? Use sensitivity analysis in PrecisionTree, draw your graph, and provide your analysis. Do not develope New Tree 25.0% High 500000 60.0% Success Chance 0 #NAME? 45.0% Medium 400000 30.0% low 300000 Devlope new product #NAME? Chance #NAME? Still work 55.0% 60000 Failure 40.0% 0 Chance #NAME? Work nothing 45.0% 0 #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? 25.0% get offer 130000 offer 1 50.0% Chance 18000 #NAME? do not get 75.0% 0 Contract 1 #NAME? Chance 30000 #NAME? 85.0% get offer 115000 offer 2 50.0% Chance 18000 #NAME? not get offer 15.0% 0 New Tree (2) Decision #NAME? 20.0% get offer 95000 Offer 1 50.0% Chance 10000 #NAME? do not get 80.0% 0 Contract 2 #NAME? Chance 15000 #NAME? get an offer 75.0% 80000 Offer 2 50.0% Chance 10000 #NAME? Branch #2 25.0% 0 #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME? #NAME?
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Explanation & Answer

See attached:)

Do not develope
0
New Tree

Decision

25.0%

High

$1,000,000.00
60.0%

Success

Chance

0

#NAME?
45.0%

Medium

$800,000.00
30.0%

low

$600,000.00
Devlope new product

#NAME?

Chance

-$300,000.00

#NAME?
Still work

55.0%
$60,000.00

Failure

40.0%
0

Chance
#NAME?
Work nothing

45.0%
0

#NAME?
#NAME?

#NAME?
#NAME?
#NAME?
#NAME?

#NAME?
#NAME?

#NAME?
#NAME?

PrecisionTree Sensitivity Analysis - Sensitivity Graph
Performed By: admin
Date: Sunday, February 24, 2019 12:22:43 PM
Output: Decision Tree 'New Tree' (Expected Value of Entire Model)
Input: Branch Value 'Medium' of Node 'Chance' (D15)

Sensitivity of Decision Tree 'New Tree'
Expected Value of Node 'Decision' (B9)
With Variation of Branch Value 'Medium' of Node 'Chance' (D15)
260000
240000

Expected Value

220000
200000

PrecisionTree Trial Version

180000

For Evaluation Purposes Only

160000
140000

Branch Value 'Medium' of Node 'Chance' (D15)

Sensitivity Data
Input

Output

#1

Value
Change (%)
$600,000.00
-25.00%

Value
Change (%)
133200
-28.85%

#2

$640,000.00

-20.00%

144000

-23.08%

#3

$680,000.00

-15.00%

154800

-17.31%

#4

$720,000.00

-10.00%

165600

-11.54%

#5

$760,000.00

-5.00%

176400

-5.77%

#6

$800,000.00

0.00%

187200

0.00%

#7

$840,000.00

5.00%

198000

5.77%

#8

$880,000.00

10.00%

208800

11.54%

#9

$920,000.00

15.00%

219600

17.31%

#10

$960,000.00

20.00%

230400

23.08%

#11

$1,000,000.00

25.00%

241200

28.85%

$1,050,000.00

$1,000,000.00

$950,000.00

$900,000.00

$850,000.00

$800,000.00

$750,000.00

$700,000.00

$650,000.00

$600,000.00

$550,000.00

120000

PrecisionTree Sensitivity Analysis - Sensitivity Graph
Performed By: admin
Date: Sunday, February 24, 2019 12:48:56 PM
Output: Decision Tree 'New Tree' (Expected Value of Entire Model)
Input: Branch Value 'low' of Node 'Chance' (D17)

Sensitivity of Decision Tree 'New Tree'
Expected Value of Node 'Decision' (B9)
With Variation of Branch Value 'low' of Node 'Chance' (D17)
220000
210000

Expected Value

200000
190000

PrecisionTree Trial Version

180000

For Evaluation Purposes Only

170000
160000

Branch Value 'low' of Node 'Chance' (D17)

Sensitivity Data
Input

Output

#1

Value
Change (%)
$450,000.00
-25.00%

Value
Change (%)
160200
-14.42%

#2

$480,000.00

-20.00%

165600

-11.54%

#3

$510,000.00

-15.00%

171000

-8.65%

#4

$540,000.00

-10.00%

176400

-5.77%

#5

$570,000.00

-5.00%

181800

-2.88%

#6

$600,000.00

0.00%

187200

0.00%

#7

$630,000.00

5.00%

192600

2.88%

#8

$660,000.00

10.00%

198000

5.77%

#9

$690,000.00

15.00%

203400

8.65%

#10

$720,000.00

20.00%

208800

11.54%

#11

$750,000.00

25.00%

214200

14.42%

$800,000.00

$750,000.00

$700,000.00

$650,000.00

$600,000.00

$550,000.00

$500,000.00

$450,000.00

$400,000.00

150000

PrecisionTree Sensitivity Analysis - Tornado Graph
Performed By: admin
Date: Sunday, February 24, 2019 1:17:38 PM
Output: Decision Tree 'New Tree' (Expected Value of Entire Model)

Tornado Graph of Decision Tree 'New Tree'
Expected Value of Entire Model

Branch Probability 'Success' of Node 'Chance' (C12)

Branch Value 'Medium' of Node 'Chance' (D15)

PrecisionTree Trial Vers...


Anonymous
Excellent resource! Really helped me get the gist of things.

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