Question

The Red Hen company is launching its new food for sale in supermarkets throughout Michigan. The sales department is convinced that its spicy chicken soup will be a great success. The marketing department is considering an intensive advertising campaign. The advertising campaign will cost $2,000,000 and if successful produce $9,600,000 in added revenue. If the campaign is less successful (25% chance), the added revenue is estimated at only $3,600,000. If no advertising is used, the revenue is estimated at $7,000,000 with probability 0.7 if customers are receptive and $3,000,000 with probability 0.3 if they are not.

Question- Should Red Hen invest in an intensive advertising campaign?

Answer 1

The decision tree of the given scenario of Red Hen Company is as follows:

Decision 1: When the company goes with the decision to conduct a Advertising campaign,

Cost of campaign = $2,000,000

Let Probability of success = p = 0.75, Probability of failure = 1-p = 0.25

Cash flow in case of success = $ 9,600,000

Cash flow in case of success = $ 3,600,000

Expected cash flow equation = 9600000p + 3600000(1-p) – 2000000

Expected cash flow = [9600000 x 0.75] + [3600000 x 0.25] – 2000000 = $ 6,100,000

Decision 2: When the company goes with the decision not to conduct a Advertising campaign,

Cost of campaign = $ 0

Let Probability of Receptive customer = q = 0.70, Probability of non- Receptive customer = 1-q = 0.30

Cash flow in case of Receptive customer = $ 7,000,000

Cash flow in case of non- Receptive customer = $ 3,000,000

Expected cash flow equation = 7000000q + 3000000(1-q) – 0

Expected cash flow = [7000000 x 0.70] + [3000000 x 0.30] – 0 = $ 5,800,000

Since the expected cash flow of decision when the company goes ahead with the Advertising campaign is greater, the company should choose decision 1 and invest in an Advertising campaign.