Question

Scenario: Film producer, Jack Magnet, is evaluating a script for a potential film. Based on that script, Magnet has initially estimated the probability of the film being a hit at 0.05, average at 0.1, and the probability of it being a flop 0.85. The studio accounting department estimates that if it is a hit, the film will make $320 million in profit, with an average take profits are estimated to be $90 million, and if a flop, will lose $50 million.

Prior to deciding whether or not to produce a film, Magnet can to decide whether or not to hire a prominent film critic to review and evaluate the script. A large number of critic’s previous reviews/assessments are available, as well as the final outcome of the associated productions. Using this information, we can calculate that, given a positive review, the probability of a hit would increase to 0.12, the probability of average would be 0.18 and of a flop 0.7. If the critic issues a negative review, the probability of a hit drops to 0.03, the probability of average drops to 0.06, with flop increasing to 0.91. In addition, the probability of a positive review has been determined to be 0.25 and a negative review 0.75. The cost for the critic’s review is $100,000.

1. Construct the associated decision tree (label decision and event nodes, and show terminal payoffs and event probabilities) and solve to determine the strategy with the highest expected net profit. State the decision strategy below the tree. (Note: can apply the associated review cost to get net profits, or use revenues and apply the costs at the appropriate decision nodes).

2. Prior to hiring the critic, what would be the calculated EVPI based upon an evaluation of the probabilities of the film being a hit, average or a flop? (Show all calculations, not just the final answer).

Answer 1

a) Associated label decision = 90/.12= 750 units

the actual profit after working expenses not included in the calculation of gross profit have been paid.Net profit is: “The profit of a company after operating expenses and all other charges including taxes, interest and depreciation have been deducted from total revenue. Also called net earnings or net income.

Net profit, also called net earnings, net income and informally ‘the bottom line’, is calculated by adding up a business’ total expenses, and subtracting that from its revenue – this shows what the company has either earned or lost over a specific accounting period, which could be one month, one quarter, six months, or one year.

The net profit of a company, organization or any individual or entity that does business, is its profit after operating expenses and all other charges including depreciation, interest, and taxes have been deducted from total revenue.

If total expenses and charges are greater than revenue, the business incurs a net loss, if expenses and charges are less than total revenue, it has made a net profit. Expenses are what the company spends.

B) Calculated EPVI =.75+.85/2=0.8 UNITS

In decision theory, the expected value of perfect information (EVPI) is the price that one would be willing to pay in order to gain access to perfect information. A common discipline that uses the EVPI concept is health economics.

1. Calculate the Expected Monetary Value (EMV) of each alternative action. Note which is the EMV* (greatest value).
2. Determine the likelihood probabilities. ...
3. Calculate the posterior probabilities. ...
4. Find the EMV of each alternative action using the posterior probabilities. ...
5. Calculate EVSI.