Problem 3

Your organization has developed a new product that has a one year life span, the organization has 2 major options; they are:

SELL PRODUCT – Sell the intellectual property and right to the product now for $1,975,000.

2) PRODUCE PRODUCT IN HOUSE – Produce the product and try to market the product themselves. Of course this has risk.

Each of these are discussed below:

PRODUCE PRODUCT IN HOUSE – if they build in house – they have two options:

Use Existing equipment or
Purchase new equipment.

Each of these options are discussed below.

Use Existing Equipment: They believe that they have an 80% probability that this will be successful. They anticipate the production cost to be $1,000,000 for the production set-up and run. Assuming the production run is successful, they have two marketing strategies. The first is with a low budget marketing strategy. Given below are the two strategies:

Table 1: $900,000 Advertising Campaign

Sales in $Millions

P(Sales $)

2

0.1

4

0.6

6

0.3

Table 2: $1.5 M Advertising Campaign

Sales in $Millions

P(Sales $)

4

0.60

5

0.2

7

0.2

In contrast to the scenario above, the company feels there is a 20% chance they will not be able to build the product using existing equipment. If production fails, there are two other options.

They could sell the patent. At this point in the process, the patent would be worth only $800,000; royalty dollars would not be available.

Purchase new equipment.

Purchase New Equipment: They are 100% confident that this will work. However the purchase price for the new equipment is $500,000 (assume that it has no value at the end of the year for the new product). Remember that the production cost is still $1,000,000. The same two marketing campaigns described above can be employed.

What do you recommend and why?

What are the expected values for each one of the 5 alternatives