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 1. Write an equation to calculate the expected value for each decision as a function of the probability that the major advertising campaign will be effective (p)?

Answer 1

The Decision Tree diagram of the Red hen company is as follows:

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

Cost of campaign = $2,000,000

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

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

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

Cost of campaign = $ 0

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

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)