Acme Incorporated is considering launching a new product. Launching the product

Question

Acme Incorporated is considering launching a new product. Launching the product will require an investment of $500 million (including marketing expenses and the costs of new facilities). The launch is risky because demand could either turn out to be low or high. There is a 50% chance that demand will turn out to be high and a 50% chance that demand will turn out to be low. If it launches the product, Acme's payoffs will be $100 million if demand turns out to be high and -$50 million if demand turns out to be low. Of course, if Acme does not launch the product, its payoff will be zero.

If Acme wants to maximize expected profit, what action should it take and what is the expected payoff?

Explanation / Answer

Prob of high demand =0.5

Prob of low demand = 0.5

Payoff(high) = $100

Payoff(low) = -$50

Expected payoff = 0.5*100+0.5*(-50)

=$50-25

=$25.

If does not launch gets 0 payoff with certainity.

Since the expected payoff is greater than 0, he it would launch he product. Expected pay off = $25

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