In: Finance
A company is deciding if it should design an advertising system for use on Twitter©. The first option is to skip out on designing, with no net costs or gains. The second option is System A, which would result in additional sales of either $50,000 under good conditions or $10,000 under bad conditions. The final choice is System B, which would increase sales by $20,000 under both good and bad conditions. Suppose that good conditions are twice as likely as bad conditions. Which option should the company pursue if developing a system costs $25,000? (14 marks – 7 for drawing decision tree, 7 marks for EMV calculation and correct suggestion of what to do)r
1) Decision tree
It is given that good conditions are twice as likely as bad conditions
Therefore, probability of good conditions = 2/3
and probability of bad conditions = 1/3
Decision tree is following:
2) EMV Calculation
EMV of skip out on designing = 0
EMV of system A = (2/3)*50000+(1/3)*10000-25000 = $ 11,666.67
EMV of system B = (2/3)*20000+(1/3)*20000-25000 = $ -5,000
Suggestion:
EMV of system A is the highest. Therefore, the company should select system A.