Gertrude Guanaco of Guanaco Electronics is examining a project to produce giggle
ID: 3051370 • Letter: G
Question
Gertrude Guanaco of Guanaco Electronics is examining a project to produce gigglebugs. They are considering whether or not to go ahead, or to first conduct market research. They have several courses of action open to them. They can
a. Go ahead and build a factory at a cost of $1.147 million. Future sales, and hence payoffs are dependent on the sale of gigglebugs. Gertrude believes that they can have poor sales (p=0.2), medium sales (p=0.5), or good sales (p=0.3). The payoffs for these three cases are $0.41 million, $1.51 million and $2.51 million respectively. The payoffs do not take the initial building costs into account.
b. Gertrude could first conduct some market research in an attempt to determine future market conditions. The market research will cost $0.3147 million. However, the company doing the market research does not always predict market conditions and sales perfectly. Past records of their ability to predict the market are tabulated below.
Actually Poor Actually Medium Actually Good
Predict poor 0.7 0.1 0.2
Predict Medium 0.2 0.6 0.3
Predict Good 0.1 0.3 0.5
Explanation: On 30% of occasions when the market conditions turned out to be medium, the researchers predicted that they would be good.
c. Gertrude could do nothing (i.e. not take the project).
What should Guanaco Electronics do? Show all calculations supporting your answer.
Explanation / Answer
Option 1 -Invest in company and get payoffs
Total expense=$1.147million
Total aggegated payoff =weighted payoff of all three posisblities
=02.*0.4+0.5*1.51+0.3*2.51= $ 2.308 millions
Gain =Payoff -expense =$1.201 Millions (option 1)
Option 2-First do the market research accounting for investment with on returns
Gain is negetive
Option 3- dont do anything
Gain =0
Thus The company must go with option 1 as it gives positive returns
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