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Computing an Expected Value using a Decision Tree

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A company is considering two alternatives for improving profits: develop new products or consolidate existing products. If the company decides to develop new products, it can either develop several products rapidly or take time to develop a few products more thoroughly. If the company chooses to consolidate existing products, it can either strengthen the products to improve profits or simply reap whatever gains are attainable without investing more time and money in the products.

Given:
The "Decision Tree Chart" attachment shows the predicted gains from each decision alternative described above. Gains depend on how the market reacts to the action taken by the company. The probability of each market reaction is shown on the decision tree.

Develop a response to the attached decision tree chart in which you:
A. Calculate the expected value for each of the four decision branches.
B. Determine the decision alternative that has the most favorable total expected value.
C. Explain how you reached your determination in part B.

Show all of your work.

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Solution Summary

This solution illustrates how to compute an expected value using a decision tree and how to use this information to choose an alternative course of action.

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A.
Expected Market Expected Probability Expected
Strategy Tactic Reaction Gain of Gain Value
Develop New Product Develop Thoroughly Good $500,000 40% $200,000
Moderate 25,000 40% 10,000
Poor ...

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