Question

A company is deciding if it should design an advertising system for use on Twitter©. The first option is to skip out on designing, with no net costs or gains. The second option is System A, which would result in additional sales of either $50,000 under good conditions or $10,000 under bad conditions. The final choice is System B, which would increase sales by $20,000 under both good and bad conditions. Suppose that good conditions are twice as likely as bad conditions. Which option should the company pursue if developing a system costs $25,000? (14 marks – 7 for drawing decision tree, 7 marks for EMV calculation and correct suggestion of what to do)

Please draw the decision tree.

Answer 1

1) Decision tree

It is given that good conditions are twice as likely as bad conditions

Therefore, probability of good conditions = 2/3

and probability of bad conditions = 1/3

Decision tree is following:

------------------------------------------------------------

2) EMV Calculation

EMV of skip out on designing = 0

EMV of system A = (2/3)*50000+(1/3)*10000-25000 = $ 11,666.67

EMV of system B = (2/3)*20000+(1/3)*20000-25000 = $ -5,000

Suggestion: EMV of system A is the highest. Therefore, the company should select system A