Question

Suppose California Baptist University (CBU) is considering creating a brand new major, Medical Science, in 2016. If CBU sticks with its current curriculum and creates no further majors, then the annual revenue will be tuition ($11.5 million), donation ($4.4 million), and research grants ($2.5 million). At the same time, CBU incurs costs such as employee salaries ($6 million), rent ($5 million), and utilities ($2.2 million) to maintain its business annually. If CBU decides to create new majors, then there are three possibilities. First, if medical research proves to be successful, and new faculty members in medical science, receive funding more actively from the state and federal government, then annual research grants are expected to increase from $2.5 to $8 million. Also, medical research alumni are likely to donate funds to CBU in the future, which also is expected to increase the amount of donation from $4.4 to $6 million, so the total revenue would increase by $7.1 million. On the other hands, the university should hire more staff/faculties in those areas, which would increase employee salaries from $6 to $8 million, while rent and utilities stay the same as under “offering no new major” option. However, business analysts expect this probability to be 35%. Second, there is also a 40% chance that faculties in medical science have a hard time receiving federal research funds due to the recession, in which case, the research grants decreases from $2.5 to $0.7 million, while revenues from tuition and donation stay the same as under “offering no new major” option. In this scenario, CBU will still have to pay employment salary ($8 million) and rent and utilities stay the same as under “offering no new major” option. Finally, uncertain economic or regional factors may lead to a huge drop in enrollment, decreasing tuition revenue. The boom in the housing market and recent drought increases rent and utilities dramatically. In other words, there is a 25% chance that CBU is suffering a loss of $3.5 million (net profits), if it chooses to offer a new major.

Question: Make a recommendation regarding whether CBU should offer a new major or stick to its current curriculum, using a decision tree (Hint: You MUST calculate the expected net profit of the option “offering a new major” and compare it to the net profit of the option of “offering no new major”)

Answer 1

*) Plan A: Revenues under new major plans implementation

Expected grant = $8*0.35 = $2.8 million

Expected donations = $6*0.35=$2.1 million

Increase in the employee’s salaries = $8*0.35 = $2.1 million

Expected increase in revenue=$7.1*0.35 =$2.485 million

Total revenue=$(2.8+2.1+2.485)= $7.385 million

Total costs=$(2.1+5.5+2.2) = $9.9 million

Net profit = $(7.385-9.9)= -$2.515 million = net loss

Plan B: Revenues under no new major plans implementation

Expected research grants=$.7 million

Salaries of employees= $8 million

Utilities cost=$2.2 million

Rent cost=$5.5 million

Revenue=$11.5 million

Donations to business=$4.4 million

Total revenues= $16.6 million

Total cost incurred=$(8+5.5+2.2) = $15.7 million

Net profit = $(16.6-15.7) = 0.9 million

So, the university must opt for plan B i.e. no new major plan implementation.