1. Chemco Corporation is a chemical company. The research and development manage

Question

1. Chemco Corporation is a chemical company. The research and development manager is trying to decide whether or not to develop a new solvent that would work at all conditions. It is thought that the solvent project may be a major success with an estimated value of $1,480,000, a moderate success with an estimated value of $820,000 since it can be sold to another company to help with its current project, or a total failure. If the project is a failure, it will cost the company $750,000. Based on the subjective judgment of the manager, the following probabilities are assigned to the three possibilities. It will cost $360,000 to conduct the research to develop the solvent. If they decide not to make the new solvent, their current market will erode by $50,000. Should the company pursue the endeavor? Be sure to draw the decision tree correctly.

P(major success) = 0.20

P(moderate success) = 0.40

P(failure) = 0.40

Explanation / Answer

Ans:If they decide to make the solvent:

Expected revenue=1480000*0.2+820000*0.4-750000*0.4

=296000+328000-300000

=324000

cost to research=360000

Hence ,net profit=324000-360000=-36000

There is actually loss of 36000,if they endeavour to make the solvent.

But there is market errosion of 50000,if they don't endeavour or loss of 50000.

So,loss in case of not making the solvent is more than in case of making the solvent.

Hence,company should pursue the endeavour to make the solvent.

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