a) A toy company is making a decision about ordering a new toy to sell during the holiday season. They are deciding whether or not to undertake market research to evaluate the potential market for the product. They have only one opportunity to order the product for this season and are committed to making either a small order or a large order.

If they choose not to undertake the research, they can make one of two choices: place a large order or place a small order. If they place an order the probability that demand is high is 50% and that demand is low is 50%.

If they undertake the market research, the chance that they will get favourable results is 45% and unfavourable results is 55%. If they get unfavourable results, the probability of high demand is 25% and of low demand is 75%. If they get favourable results, the probability of high demand is 80% and of low demand is 20%. The cost of doing the research is $10,000.

If they place a small order and demand is low the net return is $10,000. If they place a small order and demand is high the net return is $100,000. If they place a large order and demand is low the return is $-50,000. If they place a large order and demand is high the net return is $200,000.

What are the right decisions for the firm to make relative to the market research and the size of the order?

b) Now consider only the “no market research” branch of your decision tree (there should be one). If someone could tell you definitively whether demand would be high or low (without doing market research), what would be the value of knowing (i.e. the expected value of perfect information).