1.( University Bookstore has developed a new product line — a series of books written by engineering professors featuring their cutting-edge research. Management needs to decide whether to produce and market these books. One option is to immediately ramp up production and simultaneously launch an ad campaign. This option would cost $1,000. Based on experience, new book series either take off and do well or fail miserably. Hence, the prediction is for one of two possible outcomes — total sales of 2,500 units or total sales of only 250 units. University Bookstore receives a profit of $2 per unit sold. Management currently thinks that there is about a 40% chance that the production will do well (sell 2,500 units) and a 60% chance that it will do poorly (sell 250 units). Another option is to test market the product locally. The company could print a few books, put up a display in the campus bookstore, and see how they sell without any further advertising. This would require less capital for the production run and no money for advertising. The test market has two possible outcomes, sell 200 units (sell well), or only sell 20 units (sell poorly). The cost for this option is estimated to be $100. University Bookstore receives a profit of $2 per unit sold for the test market as well. The company has often test marketed products in this manner. Products that sell well when fully marketed have also sold well in the test market 80% of the time. Products that sell poorly when fully marketed also sell poorly in the test market 60% of the time. (a) Develop a decision analysis payoff table for immediately ramping up production and launching an ad campaign. Please clearly indicate the decision alternatives, the states of nature, the payoffs (profits) and prior probabilities. (b) Recommend a course of action based on 3 different criteria (explain your reasoning) based on the payoffs table from part a). e Maximin payoff * Maximum likelihood e Bayes’ decision rule (c) Calculate all the posterior probabilities after marketing the product locally using Bayes Theorem. (d) Construct the decision tree and use it to determine the optimal course of action for University Bookstore. [Hint: don’t forget to include the profits from local marketing in the branch payoffs] (e)Find EVPI & EVE. What is the maximum amount of money University Bookstore should be willing to pay to test market the new books?
