Magnatree Is a Large Company That Has Been Working on a New

question 125

Essay

Magnatree is a large company that has been working on a new product. This product has tremendous potential, but Magnatree must move quickly. They have decided that they will introduce the product in two months and have already started developing their advertising campaign.
They are sure that the product will be a success, with a possibility that it will be a huge success. They recently found out that another company, Shadycorp, has some unique expertise that could significantly improve the new product. They contacted them and Shadycorp offered to sell their expertise to Magnatree for $5 million. Magnatree needs to make an immediate decision on Shadycorp's offer or it will be too late to investigate the use of the expertise in design of the new product. Without the expertise Magnatree has a 20% chance of making the new product a huge success. With Shadycorp's expertise there will be a 40% chance of the new product being a huge success.
If the new product is a huge success, the net present value of its future profits is expected to be $50 million. If it is merely a success, the net present value of its future profits is expected to be $20 million.
(a) Construct a decision tree and solve it.
(b) Should Magnatree accept Shadycorp's offer?
(c) What is the expected net present value of its future profits from the new product?

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Definitions:

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