Question

We developed a new product, and our management believes that it will sell for one or two years before it is obsolete. Management thinks that there is 4 alternative options with this new product. The following Payoff table demonstrates all the options and the nature of each decision. Suppose a prior probability of 0.75 of the product becoming obsolete in 1 year.

Alternatives	Obsolete in 1 year [ 0.75 ]	Obsolete in 2 year [ 0.25 ]
Sell patents now	$ 1.525 (million)	$ -0.1 (million)
Sell patents for royalties	$ 0.8 (million)	$ 1 (million)
Build the product in house	$ 0.5 (million)	$ 0.75 (million)
Scrap the plan	$ 0.1 (million)	$ 0.9 (million)

a) Using the expected monetary value criterion, which option should we choose? (calculate each expected value, and state the final decision)

b) According to the maximin criterion, which alternative should we choose?

c) According to the maximax criterion, which alternative should we choose?

Answer 1

a) Using the expected monetary value criteria - EMV if 1) Sell patents now = (1.525*0.75)+(-0.1*0.25) = 1.11875

2) Sell Patients for royalties = (0.8*0.75)+(1*0.25) = 0.85

3) Build the product in house = (0.5*0.75)+(0.75*0.25) = 0.5625

4) Scrap the plan = (0.1*0.75)+(0.9*0.25) = 0.3

Therefore selling patients now will bw the choice.

b) According to maximin criteria - 1) Selling patients now = 1.525*0.75 or -0.1*0.25 = 1.14375 or -0.025 = -0.025

2) 0.8*0.75 or 1*0.25 = 0.6 or 0.25 = 0.25

3) 0.375 or 0.1875 = 0.1875

4) 0.0075 or 0.225 = 0.0075

Therefore selling patients for royalties will be the choice.

c) According to maximax criteria selling patients for royalties will be the choice.