Pfizer is a highly successful drug research company that is currently studying a new antibiotic drug. Pfizer needs to decide whether to start producing this new drug or not. If Pfizer decides to start the production, an initial investment of $1,000,000 is required at year 0. Pfizer estimates sales volume to be low with 0.35 probability, medium with 0.55 probability, and high with 0.10 probability. If sales volume is low, then Pfizer expects annual income to be $250,000 and annual costs to be $100,000 for the next 10 years. If sales volume is medium, then annual income is expected to be $400,000 and annual costs to be $180,000 for the next 10 years. If sales volume is high, then Pfizer estimates annual income to be $550,000 and annual costs to be $240,000 for the next 10 years.
In addition, Pfizer can perform one extra year of research, which will cost $150,000, before deciding whether to start the production of this new antibiotic drug or not. Pfizer believes that this extra year of research will improve the advantages of the drug such that sales volume can be low with 0.20 probability and high with 0.35 probability. In such a case, an initial investment of $900,000 is required at the end of year 1. Assume annual income and annual costs are the same described above for each corresponding probability for the next 9 years. Let MARR be 15%.
a) Draw the decision tree of this problem.
b) Calculate the expected value of present worth EV(PW).
c) What is the decision for this problem?