A new product has the following profit projections and associated probabilities:

Question

A new product has the following profit projections and associated probabilities:

0.10

a. Use the expected value approach to decide whether to market the new product.
b. Because the high dollar values involved, especially that possibility of a $100,000 loss, the marketing vice president has expressed some concern about the use of the expected value approach. As a consequence, if a utility analysis is performed, what is the appropriate lottery?
c. Assume that the following indifference probabilities are assigned. Do the utilities reflect the behavior of a rish taker or a risk avoider?

d. Use the expected utility to make a recommended decision.
e. Should the decision maker feel comfortable with the final decision recommended by the analysis?

Profit Probability $150,000 0.10 $100,000 0.25 $50,000 0.20 $0 0.15 -$50,000 0.20 -$100,00

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Explanation / Answer

To decide whether to launch a new product or not, calculate the expected profit by sum of profit (probability)

As expected value or average is positive 30000, it is advisable to launch the new product.

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Utility approach

While profit difference is the same 50000, prob is the least from 50000 units to 0

Hence 50000 units is better.

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Profit Probability Profit*prob $150,000 0.1 $15,000 $100,000 0.25 $25,000 $50,000 0.2 $10,000 $0 0.15 $0 ($50,000) 0.2 ($10,000) ($100,000) 0.1 ($10,000) Mean $30,000

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