a company is considering making a new product. they estimate the probability that the new product will be…
a company is considering making a new product. they estimate the probability that the new product will be successful is 0.75. if it is successful it would generate $240,000 in revenue. if it is not successful, it would not generate any revenue. the cost to develop the product is $196,000. use the profit (revenue - cost) and expected value to decide whether the company should make this new product.
Answer
Explanation:
Step1: Calculate profit if successful
The profit if successful is the revenue minus the cost. Revenue when successful is $240000$ and cost is $196000$. So, profit if successful $P_{s}=240000 - 196000=44000$. Profit if not - successful $P_{ns}=0 - 196000=- 196000$.
Step2: Calculate the expected - value of profit
The expected - value formula for a two - outcome situation is $E(X)=p_{1}x_{1}+p_{2}x_{2}$, where $p_{1}$ and $p_{2}$ are probabilities and $x_{1}$ and $x_{2}$ are the corresponding values. The probability of success $p_{s}=0.75$ and the probability of not - success $p_{ns}=1 - 0.75 = 0.25$. $E(X)=0.75\times44000+0.25\times(-196000)$ $E(X)=0.75\times44000-0.25\times196000$ $E(X)=33000 - 49000$ $E(X)=-16000$
Answer:
The company should not make the new product since the expected value of the profit is $-16000$ dollars.