Question

1) A fast food company, Jamburger, has 5000 locations across the U.S. The chefs at Jamburger's corporate headquarters have recently designed a new menu item, the Big Bird Ostrichburger, that the company wants to introduce to the U.S. market. For the first year in which the Ostrichburger is introduced, the company is deliberating between three different release strategies:

A Full Release across all 5000 U.S. restaurants

A Restricted Release across 2000 U.S. restaurants

A Pilot Release across just 400 U.S. restaurants

Jamburger's marketing team estimates that Initial Interest (during the first year) in the Big Bird Ostrichburger may be Strong, with 30% likelihood, or Weak, with 70% likelihood. If Initial Interest is Strong, Jamburger stands to earn $15,000 in profits per restaurant in which the Ostrichburger is initially introduced. If Initial Interest is Weak, however, Jamburger stands to lose $25,000 per restaurant that carries the Big Bird during that first year.

After the first year of introducing a new menu item, there may or may not be indicators of Sustained Demand for that item. Jamburger estimates that if there is Sustained Demand for the Jamburger, that will be worth an addition $200,000,000 in Net Present Value beyond any profits or losses from the first year. If there are no indicators of Sustained Demand, the company will simply discontinue the product after the first year with no additional profits or losses. The probabilities associated with Sustained Demand after the first year for Jamburger's Big Bird Ostrichburger are as follows:

65% if the company issued a Full Release for the Ostrichburger in the first year

50% if the company issued a Restricted Release for the Ostrichburger in the first year

35% if the company issued a Pilot Release for the Ostrichburger in the first year

The strength of the Initial Interest in the Ostrichburger has no effect upon the probabilities associated with long-term Sustained Demand.

What would be the value to the company of knowing whether Initial Interest in the Big Bird will be Strong or Weak?

Answer 1

Introduction of new product in menu- with 3 possible strategies:

Strategy A- Full Release across all 5000 U.S. restaurants

Strategy B- A Restricted Release across 2000 U.S. restaurants

Strategy C- A Pilot Release across just 400 U.S. restaurants

Probability of initial interest:

Strong 30% likelihood; return of $15000 per restaurant.

Weak 70% likelihood; loss of $25000 per restaurant.

Expected return = weight * return

ER for ''strong"- 30%*15000= $4500 profit per restaurant

ER for "weak"- 70%*25000= $17500 loss per restaurant

To find:

value to the company of knowing whether Initial Interest in the Big Bird will be Strong or Weak.

Total expected return per restaurant

Expected return= W1*R1 + W2*R2= weight(probability) 'Strong' * return 'Strong' + weight (probability) 'Weak' * return 'weak'

ER = 0.3*15000 + 0.7* (-25000) = -13000

Expected loss is $13000 per restaurant with the introduction of the new product.

Value to company :

There is a loss of $13000 per restaurant, investment in least number of restaurants is most beneficial.

Strategy A- 5000 restaurants;

Value if Strong= 5000* 4000(expected return of strong)= profit of $20,000,000

Value if weak= 5000*-17500(expected loss of weak) = loss of 87,500,000

Total expected loss (13000*5000) = $65,000,000

Strategy B- 2000 restaurants (13000*2000)= expected loss of 26,000,000

Strategy C- 400 restaurants (13000*400)= expected loss of 5,200,000

Company can save substantially by investment is strategy C of pilot release across 400 restaurants, as expected loss of introduction of ostrich burger is $13000 per restaurant.