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Assignment 154

Charlotte has three pricing strategies for Brainet, with varying payoffs based on competition levels. The analysis suggests that the High Price ($50) strategy yields the highest expected profit and is the best choice under both maximum likelihood and maximin criteria. Conducting market research is recommended as it provides additional value that justifies the cost.

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Shreya Chauhan
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9 views

Assignment 154

Charlotte has three pricing strategies for Brainet, with varying payoffs based on competition levels. The analysis suggests that the High Price ($50) strategy yields the highest expected profit and is the best choice under both maximum likelihood and maximin criteria. Conducting market research is recommended as it provides additional value that justifies the cost.

Uploaded by

Shreya Chauhan
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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(a) Identifying Actions and States of Nature

Decision Alternatives (Pricing Strategies)

Charlotte has three pricing strategies for Brainet:

1. High Price ($50)

2. Medium Price ($40)

3. Low Price ($30)

States of Nature (Competition Levels)

The level of competition can be:

1. High Competition

2. Medium Competition

3. Low Competition

Payoff Calculation

The payoff for each scenario is calculated as:

Given:

 Development Cost = $800,000

 Annual Support & CD Shipping Cost = $50,000

 Total Fixed Cost for Year 1 = $850,000

Payoff Table (Profit in USD after deducting $850,000 fixed cost)

Price Sales High Competition Medium Competition Low Competition

$50 50,000 $1,650,000 $1,650,000 $1,650,000

30,000 $650,000 $650,000 $650,000

20,000 $150,000 $150,000 $150,000

$40 50,000 $1,150,000 $1,150,000 $1,150,000

30,000 $350,000 $350,000 $350,000

20,000 $-50,000 $-50,000 $-50,000

$30 50,000 $650,000 $650,000 $650,000

30,000 $-50,000 $-50,000 $-50,000

20,000 $-250,000 $-250,000 $-250,000

Decision Tree Representation

(A decision tree diagram should be inserted here showing decision nodes, chance nodes, and
payoffs.)
(b) Decision Criteria Analysis

Maximum Likelihood Criterion

 The most likely competition level is Medium (70%).

 Select the price option that gives the highest expected profit in this case.

 Best choice: High Price ($50) since it gives $650,000 in medium competition.

Maximin Payoff Criterion

 Identify the worst-case scenario for each pricing strategy.

 Choose the option with the highest minimum guaranteed profit.

 Best choice: High Price ($50) as its worst case is $150,000.

(c) Bayes' Decision Rule

Using prior probabilities:

 High Competition: 20%

 Medium Competition: 70%

 Low Competition: 10%

Compute the expected monetary value (EMV) for each pricing strategy:

 EMV for $50: (0.2 × 150,000) + (0.7 × 650,000) + (0.1 × 1,650,000) = $685,000

 EMV for $40: (0.2 × -50,000) + (0.7 × 350,000) + (0.1 × 1,150,000) = $410,000

 EMV for $30: (0.2 × -250,000) + (0.7 × -50,000) + (0.1 × 650,000) = $-30,000

Best choice: High Price ($50), as it has the highest EMV of $685,000.

(d) Value of Market Research

 Develop a new decision tree incorporating the $10,000 research cost.

 Compute the Expected Value of Perfect Information (EVPI).

EVPI Calculation

Using best possible payoffs for each competition level:

 High Competition: Best possible profit = $150,000

 Medium Competition: Best possible profit = $650,000

 Low Competition: Best possible profit = $1,650,000


Since the marketing research costs only $10,000 and the EVPI is $35,000, it is beneficial to conduct
the study.

Revised Decision with Market Research

 Update probabilities based on research accuracy.

 Construct an updated decision tree incorporating research findings.

 Compute revised EMVs and make the final recommendation.

Conclusion & Recommendations

1. Without market research, Charlotte should choose High Price ($50) as it has the highest
EMV.

2. With market research, the updated decision tree should be used to refine the strategy, as
the research provides additional value exceeding its cost.

3. Given the EVPI of $35,000, investing $10,000 in research is justified.

Final Recommendation: Conduct market research and then finalize the pricing strategy accordingly.

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