Drink-At-Home, Inc., Statistic and Probability homework help
Drink-At-Home, Inc.
Drink-At-Home, Inc. (DAH, Inc.), develops, processes, and markets
mixes to be used in nonalcoholic cocktails and mixed drinks for home
consumption. Mrs. Lee, who is in charge of research and development at DAH,
Inc., this morning notified Mr. Dick Jones, the president, that exciting
developments in the research and development section indicate that a new
beverage, an instant pina colada, should be possible because of a new way to
process and preserve coconut. Mrs. Lee is recommending a major program to develop
the pina colada. She estimates that expenditure on the development may be as
much as $100,000 and that as much as a year's work may be required. In the
discussion with Mr. Jones, she indicated that she thought the possibility of
her outstanding people successfully developing such a drink now that she'd done
all the really important work was in the neighborhood of 90 percent. She also
felt that the likelihood of a competing company developing a similar product in
12 months was 80 percent.
Mr. Jones is strictly a bottom line guy and is concerned about the
sales volume of such a beverage. Consequently, Mr. Jones talked to Mr.
Besnette, his market research manager, whose specialty is new product
evaluation, and was advised that a market existed for an instant pina colada,
but was some-what dependent on acceptance by both grocery stores and retail
liquor stores. Mr. Besnette also indicated that the sales reports indicate that
other firms are considering a line of tropical drinks. If other firms should
develop a competing beverage the market would, of course, be split among them.
Mr. Jones pressed Mr. Besnette to make future sales estimates for various
possibilities and to indicate the present (discounted value of future profits)
value. Mr. Besnette provided Table 1.
Mr. Besnette's figures did not include (1) cost of research and
development, (2) cost of new production equipment, or (3) cost of introducing
the pina colada. The cost of the new production equipment is expected to be $
100,000 because of the special way the coconut needs to be handled, and the
cost of introducing the new product is expected to be about $150,000 because of
the point-of purchase displays that would be necessary to introduce the new
product.
Mrs. Lee has indicated that she does have alternative development
proposals, which are:
1.A reduced research program to see someone else comes out with the
product first and if not, then proceed with a crash program. The reduced
program for the first eight months would cost $10,000 per month. One advantage
of this is that if the effort was unsuccessful, then development costs would be
held to the eight-month figure (8 months X $ 10,000 = $80,000). The likelihood
of success under this approach is the same as the more orderly development.
(The likelihood of a competing company developing a product in 8 months is 60
percent.) The crash development program would take place in months 9 through 12
and would cost an additional $60,000. It would proceed only if the eight-month
study guaranteed a success.
2.Use a reduced research program and maintain an awareness of
industry developments to see if someone else develops a product. If someone
else has developed a product at the end of six months, it would cost only an
additional $30,000 to analyze their product and duplicate it. The reduced
development program would cost $10,000 per month.
Mr. Besnette, being the great marketer that he is, is of course
reluctant to be second on the market with a new product. He says that the first
product on the market will usually obtain a greater share of the market, and it
will be difficult to win those customers back. Consequently, he indicates that
only about 50 percent of the sales that he indicated in Table 1 could be
expected if Drink-at-Home waited until competing brands were already on the
market. Moreover, he suspects that there is only a 50/50 chance that the
competitor will be out with a product within the next six months.
There are four options: (1) orderly development of the pina
colada, (2) modest development effort followed by the crash program, (3) a
modest development effort for the first six months to see if a competitive
product comes on the market, and (4) do nothing.
TABLE 1 Sales and Profit Potentials
Consumer Acceptance
(Sales Potential) Probability Present
Values
(Discounted Value of Future Profits)
Substantial
0.10
$800,000
Moderate
0.60
$600,000
Low
0.30
$500,000
What do you recommend?