Question

Transcendent Technologies is deciding between developing a complicated thought-activated software, or a simple voice-activated software. Since the thought-activated software is complicated, it only has a 30% chance of actually going through to a successful launch, but would generate revenues of $50million if launched. The voice-activated software is simple and hence has a 80% chance of being launched but only generates a revenue of $10million. The complicated technology costs 10million, whereas the simple technology costs 2million.

Of the two software options, complicated software, now costing 15.5 million with a probability of success at 50%, and the simplified software, with a probability of a success at 65%, which one would the firm choose to develope if it can develop only one?

a. The simple voice-activated software

b. The complicated thought-activated software

c. Neither of the software

d. Need more information

Answer 1

To tell which software should the firm develop we need to check which software will generate a higher expected net payoff, expected singe we there is probability of software being successful and generating revenue.

Let's first calculate the expected net payoff for thought - activated software.

Net expected payoff = expected revenue - cost

Let's first calculate the expected revenue from thought-activated software.

Expected revenue = probability of being successful × revenue it would generate

The probability with which thought-activated software is going to successful is 30% or 0.3 and on being successful it will generate revenue of $50 million.

Expected revenue = 0.3 × $50 million

Expected revenue = $15 million.

But since now the probability of success for complicated software is 50% or 0.5 then the expected revenue will be,

Expected revenue = 0.5 × $50 million

Expected revenue = $25 million

And the cost of developing complicated software is now costing $15.5 million. So the expected payoff for the complicated software is equal to,

= $25 million - $15.5 million

= $9.5 million.

So the net expected payoff from complicated software is $9.5 million.

​​​​​Similarly we need to calculate the net expected payoff for simple software and then compare it with the net expected payoff from complicated software.

The probability with which simple software is going to be successful is 80% or 0.8 and it will generate a revenue of $10 million.

But now notice the probability with which the simplified software will be successful is 65% or 0.65. So the expected revenue from simplified software will be equal to,

= 0.65 × $10 million

= $6.5 million.

And cost of developing this simplified software is equal to $2 million. So the net expected payoff from simplified software is,

= $6.5 million - $2 million

= $4.5 million

So the net expected payoff from simplified software is $4.5 million.

Now as we can see that the net expected payoff from developing a complicated that is the thought-activated software is $9.5 million whereas the net expected payoff from developing a simple that is voice-activated software is $4.5 million. So the net expected revenue for the complicated software that is thought-activated software is higher than developing the simple software voice-activated software.

So the firm must choose to develop the complicated thought-activated software.

The correct answer is option B.

I hope I was able to help you.

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