Question: A company has already spent $80,000 developing a new product, and is now considering whether or not to market the product.

Tooling for production of the new product would cost $50,000.

If the product is produced and marketed, the company estimates that there is only one chance in four that the product would be successful. If successful, the net income would be $100,000 per year for 8 years.

If not successful, the company would lose $30,000 per year for 2 years, after which time the venture would be terminated. The minimum rate of return on the capital is 20% per year.

1. Draw a decision tree and determine the best alternative using the expected net present value criterion.

2. There is a market research group that can provide perfect information about the success or otherwise of the product at a cost of $20,000. Should the company engage the market research group? Your work should include a decision tree, relevant calculations and explanation to justify your answer.

Note: In your calculations for part (2) of the question, use the same probabilities for the outcomes of the market research as indicated above, i.e. one in four for success.