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?

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.