Question

58. Kroft Food Products is attempting to decide whether it should introduce a new line of salad dressings called Special Choices. The company can test market the salad dressings in selected geographic areas or bypass the test market and introduce the product nationally. The cost of the test market is $150,000. If the company conducts the test market, it must wait to see the results before deciding whether to introduce the salad dressings nationally. The probability of a positive test market result is estimated to be 0.6. Alternatively, the company can decide not to conduct the test market and go ahead and make the decision to introduce the dressings or not. If the salad dressings are introduced nationally and are a success, the company estimates that it will realize an annual profit of $1.6 million, whereas if the dressings fail, it will incur a loss of $700,000. The company believes the probability of success for the salad dressings is 0.50, if they are introduced without the test market. If the company does conduct the test market and it is positive, then the probability of successfully introducing the salad dressings increases to 0.8. If the test market is negative and the company introduces the salad dressings anyway, the probability of success drops to 0.30.

Using decision tree analysis, determine whether the company should conduct the test market. (make sure ti write all steps with all calculation)

Answer 1

The decision tree for the given scenario is given as below

We need to find the expected value (EV) for each of the option - introducing without the test market and with the test market.

EV at point B is the one without the test market. This is given as 1600000*0.5-700000*0.5 = $1150000

If the test market is conducted, then there is a certain cost of 150000. Additionally we need to find the EV at point A. To find this we first need to find EV at point C and D.

EV at C = 0.3.*1600000-0.7*700000 = -10000

EV at D = 0.8*1600000-0.2*700000 = 1140000

EV at A is then given as 0.4*(-10000)+0.6*(1140000) = 680000

Total EV of conducting a test market is thus 680000 - 150000 = $530000

Thus we can see that the EV of introducing without the test market is higher than EV of conducting the test market. Hence the company should not conduct the test market