This is my homework but i don't need help to solve it.
I just need your views about the development cost of project A. I just find it odd that the initial cost of project A is already 100 millions and more than any possible profit reaped for Project A and Project B. Thus, even without embarking on the decision tree, the choice will be project B.
Do you read the question as such? Did my professor overlooked this? I checked with him and his reply was just do it.
Here is the question.
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Jamie is the head of product development team at Three Stars Electronics (TSE). Currently, Jamie is evaluating two product development projects. Those two potential products are code named as Product A and Product B.
Product A will be designed for the US market. If Jamie chooses Product A project, Jamie has to decide whether it will be developed as high end product or low end product. The size of profit TSE will get from Product A depends on the performance of American economy. The best guess at the moment is that there are 60% chance that American economy will be good by the time Product A will be on the market. However, there are 40% chance that American economy will do poorly when the Product A will hit the market.
If American economy is doing good, low end designed Product A will deliver USD15 million profit to TSE. If American economy is doing poorly, low end designed Product A will deliver the profit of USD10 million. However, there is a little bit tricky part for the development of the high end designed Product A. High end designed Product A will require a specific component called Alpha. The problem is Alpha is still under development stage and early test results indicate that the component may catch fire under certain circumstances. Jamie needs Alpha to be ready in two-month time to complete the development of high end Product A. When Jamie asked their honest opinion on the chance of Alpha being ready in two months, the head of research department replied, “It is 50-50, Jamie. That is my fair judgement.”
If Alpha is not ready, the high end designed Product A should be shipped with component Beta which is already available from the older generations of products. However, high end designed Product A with component Beta will be seen as a joke. Even American economy is doing well when Product A hits the market, it will result in a loss of USD10 million. If American economy is doing poorly when Product A hits the market, it will result the loss of USD40 million. Nevertheless, abandoning the development of Product A is not an option since Jamie will be personally responsible for the write-off of the development expenses of USD100 million.
However, if the development of Alpha is completed within time, high end designed Product A with the component Alpha will deliver the profit of USD 40 million if US economy is doing well. Even American economy is doing poorly, high end designed Product A will still deliver the profit of USD15 million.
Product B will be designed for Japanese market. Product B can also be designed for high end product or low end product. If Product B is designed for high end product, it will require a special component called Jetta. Jetta is shipped from a sole supplier in Japan. Unfortunately, the diplomatic relationship between TSE’s country and Japan has been very shaky in recent months. There are about 20% chance that Japanese government blocks the shipment of Jetta to TSE by the time that the development project of Product B needs the component.
If Jetta is not available, Product B has to be designed as a low end product. The low end designed Product B will return the profit of USD12 million to TSE if Japanese economy is strong when Product B is introduced to the market. If Japanese economy is weak, low end designed Product B will return the profit of USD8 million. Even if Jetta is available, it is still up to Jamie whether to develop Product B as a high end product or a low end product. If Japanese economy is doing good, high end designed Product B will return the profit of USD20 million. On the other hand, high end products do not sell well in Japan when economy is poor. If Japanese economy turns out to be weak when Product B hits the market, high end designed Product B will only deliver the profit of USD1 million.
At the moment, the outlook for Japanese economy is not as good as American’s. There are 70% chance that Japanese economy will be weak when Product B will be introduced to the market. There are only 30% chance that Japanese economy will be strong.
I believe that the term "profit/loss" refers to the amount of money you get after accounting for expenses. So, if product A delivers a profit of \$10 million, this means that you originally received around \$110 million in sales, then after spending \$100 million to recover development cost, then got to keep the remaining \$10 million as profit.
(From the point of view of a homework question, though, saying that the development costs were steep is simply a way to say that you must release Product A if you develop it; you're not allowed to abandon it.)