For five years, a firm has successfully marketed a package of multitask software. Recently, sales have begun to slip because the software is incompatible with a number of popular application programs. Thus, future profits are uncertain. In the software’s present form, the firm’s managers envision three possible five-year forecasts: maintaining current profits in the neighborhood of $2 million, a slip in profits to $.5 million, or the onset of losses to the tune of $1 million. The respective probabilities for these outcomes are .2, .5, and .3. An alternative strategy is to develop an “open,” or compatible, version of the software. This will allow the firm to maintain its market position, but the effort will be costly. Depending on how costly, the firm envisions four possible profit outcomes: $1.5 million, $1.1 million, $.8 million, and $.6 million, with each outcome considered equally likely. a. Which course of action produces greater expected profit? b. Roughly speaking, which course of action appears to be less risky? If management were risk averse, would this fact change its preferred course of action?
For five years, a firm has successfully marketed a package of multitask
software. Recently, sales have begun to slip because the software is
incompatible with a number of popular application programs. Thus,
future profits are uncertain. In the software’s present form, the firm’s
managers envision three possible five-year
profits in the neighborhood of $2 million, a slip in profits to $.5 million,
or the onset of losses to the tune of $1 million. The respective
probabilities for these outcomes are .2, .5, and .3.
An alternative strategy is to develop an “open,” or compatible,
version of the software. This will allow the firm to maintain its market
position, but the effort will be costly. Depending on how costly, the firm
envisions four possible profit outcomes: $1.5 million, $1.1 million, $.8
million, and $.6 million, with each outcome considered equally likely.
a. Which course of action produces greater expected profit?
b. Roughly speaking, which course of action appears to be less risky? If
management were risk averse, would this fact change its preferred
course of action?
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