Analytical Case Study #3 Assignment
Decision Tree Analysis
Please take the time to carefully analyze the Decision Trees Exercise attached below, and then try to answer the following questions.
Please prepare for a written report and then submit it via Canvas’ Module #10.
** Please note that you need to show all the steps of your calculations (including ‘decision tree’) to receive full.
The TigerStorage Optical Media Company has developed a new storage device for computers and must now decide what to do with the idea. The expected life of the product is eight years. One possibility is to immediately license the product rights to another company that will market and sell the product. The best estimate for this alternative is a payoff of $5.5 million in licensing fees. Two other possibilities are to build a large manufacturing plant now to produce the product or build a small plant now to produce the product with the option of expanding the plant in three years. The expected payoff from producing the product depends on the market acceptance of the product during the first three years and during the last five years. If the market acceptance in the first three years is low, TigerStorage will stop production and cut its losses at that point. Analysts at TigerStorage have estimated a 70 percent probability of high market acceptance in the first three years.
If the market acceptance is high in the first three years, they believe the probability of a high market acceptance in the next five years to be 60 percent. The following tables give the net payoff estimates (in $ millions) for producing the product:
Market Acceptance Large
Plant Small Plant
Don’t Expand Small Plant
First 3 Years Next 5 Years
High High $15 $10 $12
High Low 4 6 4
Low — (2) 3 —
Note: ( ) means a negative payoff.
Using these estimates, analyze which decision TigerStorage should make:
1. Perform a complete decision tree analysis.
2. Recommend a strategy to TigerStorage (which alternative would be most attractive?)
3. Determine what payoffs will result from your recommendation.