Mark M. Upp has just been fired as the university bookstore manager for setting

Question

Mark M. Upp has just been fired as the university bookstore manager for setting prices too low (only 20 percent above suggested retail). He is considering opening a competing bookstore near the campus, and he has begun an analysis of the situation. There are two possible sites under consideration. One is relatively small, while the other is large. If he opens at Site 1 and demand is good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at Site 2 and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if demand is low. He also has the option of not opening at either site. He believes that there is a 50 percent chance that demand will be high. A market research study will cost $5,000. The probability of a good demand given a favorable study is 0.8. The probability of a good demand given an unfavorable study is 0.1. There is a 60 percent chance that the study will be favorable.

(a) Should Mark use the study? Why?

(b) If the study is done and the results are favorable, what would Mark's expected profit be?

Explanation / Answer

Expected profit from Site1= 0.5*50000-0.5*10000=20000

Expected profit from Site2= 0.5*80000-0.5*30000=25000

Expected profit from not opening site =0

Maxm Expected profit=25000

Cost of market study = 5000

If mark goes for study,

expected profit from site1= .6*0.8*50000-0.6*0.2*10000+0.4*0.1*50000-0.4*0.9*10000=21200

expected profit from site2= .6*0.8*80000-0.6*0.2*30000+0.4*0.1*80000-0.4*0.9*30000=27200

Maxm Expected profit=27200

a.) Expected payoff form Study=27200-25000=2200 which is less than the cost of study.

Mark shouldn't use the study

b.)A favorable study has been done

expected profit from site1= 0.8*50000-0.2*10000=38000

expected profit from site2= 0.8*80000-0.2*30000=58000

Mark's expected profit would be $58000

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