response to be .40. MD predicted an expected profit of $50 million if the
response proved to be strong. If the immediate customer response was weak,
management believed that all was not lost. If MD could persuade the
majority of its franchisees to back and help fund the campaign, the resulting
profit would be $20 million. However, if the majority rose up against the
campaign, the red ink would fly, and McDonald’s profit would be -$100
million. MD considered these two outcomes to be equally likely.
a. Given these assessments, construct a decision tree to determine MD’s
expected-profit-maximizing course of action.
b. Suppose that MD has the flexibility to try the campaign but to
terminate it if the initial response is weak, thereby limiting its total
loss to $20 million. (It must pull the plug before knowing whether
the franchisees are for or against the campaign.) Again, construct a
decision tree to determine MD’s expected-profit-maximizing strategy.- As CEO of firm A, you and your management team face the decision of
whether to undertake a $200 million R&D effort to create a new mega-
medicine. Your research scientists estimate that there is a 40 percent
chance of successfully creating the drug. Success means securing a
worldwide patent worth $550 million (implying a net profit of $350
million). However, firm B (your main rival) has just announced that it is
spending $150 million to pursue development of the same medicine (by
a scientific method completely independent of yours). You judge that B’s
chance of success is 30 percent. Furthermore, if both firms are
successful, they will split equally the available worldwide profits
($275 million each) based on separate patents.
a. Given its vast financial resources, firm A is risk neutral. Should firm A
undertake the $200 million R&D effort? (Use a decision tree to justify
your answer.)
b. Now suppose that it is feasible for firm A to delay its R&D decision
until after the result of B’s R&D effort (success or failure) is known. Is
it advantageous for firm A to have this “second move”? (Use a
decision tree to justify your answer.)
c. Instead, suppose that firm A and firm B can form a joint venture to
pursue either or both of their R&D programs. What is the expected
profit of simultaneously pursuing bothprograms? Hint:Be sure to
compute the probability that both efforts fail(in which case the firms’
combined loss is 200 150 $350 million.). Could the joint venture
profitably pursue a singleprogram?
*11. Filene’s Basement, a Boston-based department store, has a policy of
marking down the price of sale items each week that they go unsold. You
covet an expensive brand of winter coat that is on sale for $100. In fact,
536 Chapter 12 Decision Making under Uncertainty*Starred problems are more challenging.c12DecisionMakingunderUncertainty.qxd 9/29/11 1:34 PM Page 536