Colaco currently has assets of 150,000 and wants to decide whether to market a new chocolate...

Question:

Colaco currently has assets of 150,000 and wants to decide whether to market a new chocolate flavored soda, Chocola. Colaco has three alternatives:

Alternative 1: Test market Chocola locally, then utilize the results of the market study to determine whether of not to market Chocola nationally.

Alternative 2: Immediately market Chocola nationally.

Alternative 3: Immediately decide not to market Chocola nationally.

In the absence of market study, Colaco believes that Chocola has a 55% chance of being a national success and 45% chance of being a national failure. If Chocola is a national success, then Colaco's assets will increase by 300,000 and if Chocola is a national failure, Colaco's assets will decrease by 100,000.

If Colaco performs a market study ( at a cost of 30,000) there is a 60% chance that the study will yield favorable results ( referred to as a local success) and 40% chance that the study will yield unfavorable results ( referred to as a local failure). If a local success is observed there is an 85% chance that Chocola will be a national success. If a local failure is observed, there is only a 10% chance that Chocola will be a national success.

Draw the decision tree and determine the decision that will maximize Colaco's expected final decision.

Decision Tree

Decision Tree is the systematic representation of the data, facts and figures by using the symbols or signs. The decision tree includes all the possible outcomes or alternative which help the analyzer to take appropriate decision.

Answer and Explanation:

Decision Tree

Alternative 1: Performs Market Study

Option: Favourable Market

{eq}\begin{align*} {\rm{Expected}}\,{\rm{Payoff}} &= (\$ 300,000 \times 0.85) - (\$ 100,000 \times 0.1)\\ &= \$ 255,000 - \$ 15,000\\ &= \$ 240,000 \end{align*} {/eq}

Option: Unfavourable Market

{eq}\begin{align*} {\rm{Expected}}\,{\rm{Payoff}} &= (\$ 300,000 \times 0.85) - (\$ 100,000 \times 0.9)\\ &= \$ 30,000 - \$ 90,000\\ &= - \$ 60,000 \end{align*} {/eq}

{eq}\begin{align*} {\rm{Net}}\,{\rm{Expected}}\,{\rm{Payoff}} &= \$ 240,000*0.6 - \$ 30,000\\ &= \$ 144,000 - \$ 30,000\\ &= \$ 114,000 \end{align*} {/eq}

Note: The cost of market test will be deducted from the net payoff.

Alternative 2: Immediately market Chocola nationally.

{eq}\begin{align*} {\rm{Expected}}\,{\rm{Payoff}} &= (\$ 300,000 \times 0.55) - (\$ 100,000 \times 0.45)\\ &= \$ 165,000 - \$ 45,000\\ &= \$ 120,000 \end{align*} {/eq}

Alternative 3: Immediately decide not to market Chocola nationally.

The company will not invest and will have the net asset of $150,000

Conclusion: The expected payoff is higher in alternative 2. Therefore, it should be implement.


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What Is a Decision Tree? - Examples, Advantages & Role in Management

from Introduction to Management: Help and Review

Chapter 2 / Lesson 12
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