ACCA PM · Chapter 9 · Question 8 of 11
A company is deciding whether to launch a product at a cost of $100,000. There is a 0.6 probability of success, giving a return of $300,000. If the launch fails (probability 0.4), the company can either abandon the product and sell the equipment for $50,000, or spend $30,000 modifying it, in which case there is a 0.5 probability of a return of $200,000 and a 0.5 probability of a return of $20,000. All values are in present value terms. What is the expected value of launching the product, assuming the best choice is made at each decision point?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: C) $112,000
Explanation
Roll back from the right. If the launch fails: modifying gives (0.5 x $200,000) + (0.5 x $20,000) - $30,000 = $80,000, which exceeds the $50,000 from abandoning, so modify. EV of launch = (0.6 x $300,000) + (0.4 x $80,000) - $100,000 = $112,000.
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