Senior management at Optel, an optical switch manufacturer, is faced with the problem of determining whether or not to develop a new "terra-power" optical switch. The research and development (R&D) costs of developing such a switch is estimated to be $25 million. If the company goes ahead with the R&D and develops the switch, a crucial issue is whether or not the switch will be viewed by customers as superior to existing optical switches available in the market (and thus worth paying more for). The company assesses a probability of 0.6 that the switch will be viewed as superior, and 0.4 that the switch will be viewed as inferior.
After the initial R&D decision is made, and dependent upon the product's image (i.e., after they know whether it is viewed as superior or inferior), the company needs to decide whether to produce and market the switch. If they decide to produce and market the switch, its success depends on whether Optel's main competitor, Lucent Technologies, reacts and develops a competing product. Optel assesses a probability of 0.8 that there will be a competing optical switch by Lucent if Optel's switch is viewed as a superior product. They also assess a probability of 0.3 that there will be a competitive optical switch by Lucent if Optel's switch is viewed as an inferior product.
If Optel's switch is viewed as a superior product then Optel estimates that it will gross $150 million in profits (if produced and marketed) if there is a competitive product, and $350 million in profits (if produced and marketed) if there is no competitive product. If Optel's switch is viewed as an inferior product then Optel estimates that it will lose $150 million (if produced and marketed) if there is a competitive product and will make $30 million in profits (if produced and marketed) if there is no competitive product. All of these numbers do not include the R&D costs.
(a) Structure Optel's senior management's problem as a decision tree.
(b) Using the EMV criteria (you wish to maximize expected profits in this case) determine what course of action that Optel should take. Make sure to state the best strategy in words.