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FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Successful 0.5 Start R&D Project ($5 million), Not Successful 0.5 Do Not Start the R&D Project 1-1 Building Facility ($20 million) Sell Rights Profit ($ millions) 34 20 10 20 -5 High Demand 0.5 Medium Demand 0.3 Low Demand 0.2

FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Successful 0.5 Start R&D Project ($5 million), Not Successful 0.5 Do Not Start the R&D Project 1-1 Building Facility ($20 million) Sell Rights Profit ($ millions) 34 20 10 20 -5 High Demand 0.5 Medium Demand 0.3 Low Demand 0.2

Purchasing and Supply Chain Management
Purchasing and Supply Chain Management
6th Edition
ISBN:9781285869681
Author:Robert M. Monczka, Robert B. Handfield, Larry C. Giunipero, James L. Patterson
Publisher:Robert M. Monczka, Robert B. Handfield, Larry C. Giunipero, James L. Patterson
ChapterC: Cases
Section: Chapter Questions
Problem 5.2SB
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17. Hemmingway, Inc., is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facil- ity is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million production facility. The decision tree is shown in Figure 13.18. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59 - $5 - $20 = $34 million. Branch probabilities are also shown for the chance events. a. Analyze the decision tree to determine whether the company should undertake the R&D project. If it does, and if the R&D project is successful, what should the company do? What is the expected value of your strategy? b. What must the selling price be for the company to consider selling the rights to the product? c. Develop a risk profile for the optimal strategy.
Transcribed Image Text:17. Hemmingway, Inc., is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway's president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facil- ity is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million production facility. The decision tree is shown in Figure 13.18. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59 - $5 - $20 = $34 million. Branch probabilities are also shown for the chance events. a. Analyze the decision tree to determine whether the company should undertake the R&D project. If it does, and if the R&D project is successful, what should the company do? What is the expected value of your strategy? b. What must the selling price be for the company to consider selling the rights to the product? c. Develop a risk profile for the optimal strategy.
FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Successful 0.5 Start R&D Project ($5 million) Not Successful 0.5 Do Not Start the R&D Project Building Facility ($20 million) Sell Rights Profit ($ millions) 34 20 10 High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 20 0
Transcribed Image Text:FIGURE 13.18 DECISION TREE FOR HEMMINGWAY, INC. Successful 0.5 Start R&D Project ($5 million) Not Successful 0.5 Do Not Start the R&D Project Building Facility ($20 million) Sell Rights Profit ($ millions) 34 20 10 High Demand 0.5 Medium Demand 0.3 Low Demand 0.2 20 0
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