15 Feb R&D Project. Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway’s president is concerned becau

R&D Project. 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. Furthermore, 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.
The decision tree follows. The profit projection for each outcome is shown at the end
of the branches. For example, the revenue projection for the high demand outcome is $59
million. However, the cost of the R&D project ($5 million) and the cost of the production
facility ($20 million) show the profit of this outcome to be $59 2$5 2$20 5$34 million.
Branch probabilities are also shown for the chance events.
a. Analyze the decision tree to determine whether the company should undertake the
R&D project. If it does, and if the R&D project is successful, what should the company
do? What is the expected value of your strategy?
b. What must the selling price be for the company to consider selling the rights to the
product?
c. Develop a risk profile for the optimal strategy.