Decision Making, Incremental Analysis

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Chapter 7

PROBLEM 7-1 Decision Making and Ethics (LO 1, Ethics)

Joan Paxton, VP of marketing for Supertone Recording Equipment, has developed a marketing plan for presentation to the company’s president. The plan calls for television ads, something the company has never used. As part of her presentation, she will indicate the impact of the TV ads on company profit as follows:

Incremental sales from increased exposure		$9,000,000
Less:
Incremental cost of goods sold	$3,900,000
Cost of TV ads	2,500,000	6,400,000
Incremental profit		$2,600,000

While Joan is quite confident in the cost of the ads and the incremental cost of goods sold if sales are $9,000,000, she is quite uncertain about the sales increase. In fact, she believes that her estimate is on the high side. However, she also believes that if she puts in a more conservative estimate, such as $7,000,000, the president will not go along with the TV ads even though they still generate substantial profits at $7,000,000 of incremental sales.

Required

Is it unethical of Joan to bias her estimate of incremental sales on the high side, given that she believes the ultimate outcome is in the best interest of the company?

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Quantitative Method Problem - Hemmingway, Inc.

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Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway’s president is concerned because the probability that the R&D project will be successful is only 0.50. Secondly, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facility is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million.  Under this option, the company would not build the $20 million production facility.

Probability: Expected Value and Decision Analysis

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1- In a certain state lottery, a lottery ticket cost $8. In terms of the decision to purchase or not to purchase a lottery ticket, suppose that the following payoff table applies:

                                State of nature
Decision alternative           Wins s1        Lose s2
Purchase lottery ticket d1           290,000             -8
Do not purchase lottery ticket d2        0              0

1. A realistic estimate of the chances of winning are 1 in 290,000. Use the expected value  approach  to recommend a decision.

Decision Analysis - Real Estate Investor

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A real estate investor has the opportunity to purchase land currently zoned residential.  If the county board approves a request to rezone the property as a commercial with the next year, the investor will be able lease the land to a large discount firm that wants to open a new store on the property.  However, if the zoning change is not approved, the investor will have to sell the property at a loss.  Profits (in thousands of dollars) are shown in the following payoff table.

                                                                                State of Nature

                                                Rezoning Approved                        Rezoning Not approved

Decision Alternative                       s₁                                                                                           s₂

Purchase, d₁                                                          600                                                         -200

Purchase, d₂                                                          0                                                              0

a) If the probability that the rezoning will be approved is 0.5, what decision is recommended? What is the expected profit?