Question

The company that you manage has invested $5 million in developing a new product, but the...

The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

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Answer #1

If the firm not able to complete the project then it will receive $0 as revenue and it already has invested $5 million, which means

Profit = Revenue - cost

= $0 - $5 million

= -$5 million

Loss of $5 million

If firm complete the project the cost increase to $6 million as 41 million more invested also revenue increases by $3 million

Profit = $3 million - $6 million

= -$3 million

Loss of $3 million

So to reduce the loss, the firm must must $1 million and complete the project.

The most the firm pay to complete the project is $3 million which makes the firm indifferent between finishing the project with additional cost or left the project unfinished.

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