Answer:
<u>Consider the following information</u>
Probability of ATR coming up with a competitive product is 0.35
If ATR does not come up with a competitive product and H adds an assembly line, the profit is $60,000
If it adds an assembly line and ATR adds the product, the profit is $20,000
If H adds a new assembly but ATR does not come up with a competitive product, the profit is $600,000
If ATR does not enter the market, the loss for H is $120,000
<u>A) Expected value for the add assembly line option:
</u>
The company would get a profit of $60,000 if ATR does not come up with a competitive product. If ATR comes up with a competitive product and H adds an assembly line, the profit is $20,000.
Probability of not coming up with a product is 0.65 (1-0.35)
Calculate the value if it does not come up with a new product line and H adds an assembly line as follows:
Value if it does not come up with a new product = 0.65 x $60,000
= $39,000
Calculate the value if it comes up with a new product line and H adds an assembly line as follows:
Value if it does come up with a new product = 0.35 x $20, 000 = $7,000
Calculate the expected value as follows:
Expected value = S39000 + $7000
Expected value =$46,000
<u>Expected value for build new plant option:
</u>
If H adds a new assembly but ATR does not come up with a competitive product, the profit is $600,000
If ATR does not enter the market, the loss for H is $120,000
Calculate the value if H adds a new assembly but ATR does not come up with a competitive product as follows:
Value if it does not come up with a new product = 0.65 x $600000
= $390, 000
Calculate the value if ATR does not enter the market:
Value if it does not compete in market = 0.35 x -$120000 = -$42, 000
Calculate the expected value as follows:
Expected value= $390,000 - $42,000
Expected value =$348,000
The expected value of building a plant is more than the expected value of adding product line. Therefore, the best alternative is to build the plant.
<u>B) Calculation of expected value of perfect information (EVPI):
</u>
EVPI = 0.65 x $600,000 + 0.35 x $120,000
EVPI = $390,000 + $42,000
EVPI =$432,000
<u>Calculation of value of return:
</u>
Value of return = Value of perfect information - Maximum EMV
Value of return =$432,000 - 348,000
Value of return =$84,000
