BUAD 346 Question For Decision Making

Murphy BUAD346 – Spring 2020

Case 1

Instructions for Completion:

· Read the case information included and complete the necessary work.

· Document a response to each question neatly and clearly (handwritten or typed, it’s your decision). Show ALL mathematics, rounding to 2 decimal points.

· Be sure to number/letter your responses to correspond to the questions. Failure to do so may impact your score.

· Circle or highlight each final answer you provide.

· Complete the Case Cover Sheet (provided) to include partner names and staple it atop your answer pages (in question number order).

· Do NOT submit in a folder, with a different cover, other bindings, etc. All I want is your Case Cover Sheet and your work effort (do not attach the questions… just the answers). Keep it simple.

Grading Rubric:

60 points:

Data Preparation (Probability Calculations) – 15 pts

Model Development (Decision Tree) – 15 pts

Data Analysis – 15 pts

Succinctness/Validity of Non-Mathematical Responses - 5

Attention to Instructions - 5

Timely Submission - 5

Reminder About Work Effort:

You are expected to work on this case exercise solely with your partner. Working with other students or discussing methodologies is not permitted.

BUAD346-Murphy

Case 1 Submission

Due: Friday, March 20, 2020

Submitted by:

Jun Guo

Case Information:

“Citizen’s Agenda” is a band that performs in the Mid Atlantic area. The group has recently made contact with a music producer and is trying to convince him to produce its first album. If the album is produced, the record label will conduct a massive nationwide marketing campaign. Even with the campaign, the producer believes that sales for their album could either be huge or abysmal. After considering all of the costs for recording, manufacturing, advertising/promotion, distribution and fixed payments (to the group members), the producer estimates a net profit of $400,000 if the release is a success. If it flops, the label would lose $200,000. The producer has serious reservations as to whether the album release will succeed and assigns a 30% likelihood to this outcome.

1. What is the producer’s initial decision given the above information?

Answer: The initial information that given to the producer are if the release is a success that he will make about 400,000 dollars net profit. However, if the release flops, the band will lose about 200,000 dollars. Based on the data points from before, he knows that there is a 30% chance the release will be succeed.

Just as he is about to tell the band of his decision, the producer is approached by a friend at Music Insights Inc. (MII) who has developed a new, unique research process to gauge purchase habits of music-buying audiences. Her process is incredibly accurate in making predictions and, as such, she charges a significant amount for the effort: $150,000.

2. Should the producer pay for this information? Why or why not.

We need to find the Expected Value of Perfect Information to decide whether to hire or not his friend to predict the outcome.

Expected Value of Perfect Information (EVPI) = Expected Value with perfect information (EVwPI) - Max. EMV

EVwPI = (Best Outcome for 1st state of nature i.e. Success) * (Probability of 1st state of nature) + (Best Outcome for 2nd state of Nature i.e. Failure) * (Probability of 2nd state of nature)

The best outcome for the state of nature "Success" is to launch the product with a payoff of $400000. The best outcome for the state of nature "Failure" is not to launch the product with a payoff of $0.

EVwPI = 0.30 * 400000 + 0.70*0 = $ 120000

Max. EMV = 0 (As explained in the answer 1)

EVPI = EVwPI - Max. EMV = 120000 - 0 =120000

The most the produce should pay for the perfect information is $ 120000.

His friend charge $ 150000 so it not worth to get the perfect information.

The producer and his staff decide that a standard, internal market survey could be conducted to gather partial or imperfect information before making a decision. It would focus on 2 test markets and would cost $20,000 to complete. In the past, similar surveys have often predicted quite accurately the success or failure of a new record, but occasionally a record is a failure even if it’s been predicted to be a success (and vice versa). In some cases, the results of the survey turn out to be inconclusive (no indication of success or failure).

The market research manager for the label has identified the following probabilities to the possible survey results for the two possible sales levels:

	Actual Level of Sales
Survey Prediction	High Sales (Huge Success)	Low Sales (Abysmal)
Success	.3	.2
Inconclusive	.5	.5
Failure	.2	.3

3. Using the probability data, compute the following:

a) P (Success | Survey predicts success) = 0.3 / (0.3+0.2) = 0.6

b) P (Failure | Survey predicts success) = 0.2 / (0.3+0.2) = 0.4

c) P (Success | Survey inconclusive) = 0.5 / (0.5+0.5) = 0.5

d) P (Failure | Survey inconclusive) = 0.5 / (0.5+0.5) = 0.5

e) P (Success | Survey predicts failure) = 0.2 / (0.2+0.3) = 0.4

f) P (Failure | Survey predicts failure) = 0.3 / (0.2+0.3) = 0.6

g) P (Survey predicts success) = (0.3+0.2) / 0.25

h) P (Survey inconclusive) = (0.5+0.5) / 0.5

i) P (Survey predicts failure) = (0.3+0.2) / 0.25

4. Develop a decision tree to aid in the decision process. Show all relevant decisions, states, probabilities and payoffs.

5. For each of the three possible outcomes of the survey, what is the best decision? Explain briefly.

Answer: The inconclusive is the best decision. After I draw the decision tree, by calculating the EMV of the possible outcome, I record the EMV_success as 40,000 dollars, the EMV_inconclusive as 50,000 and the EMV_failure as 5,000. So, if the survey come up with inconclusive will be the best decision to make.

6. Should the record label conduct the survey or not? Explain in brief statement. Defend with mathematics.

Answer: EvwSI = 50,000 EMV_max = 0 (-20000) EVSI =|EVwSI – EvwoSI| = 50,000 – 0 = 50,000

EVSI – survey fee = 50,000 – 20,000 = 30,000

With the survey, the company will make more profit than without the survey. Since the EMV without the survey will be -20,000, the company should not even launch the album without conducting any type of research or survey of the market.

7. What is the maximum amount the label should be willing to spend to conduct the survey?

Answer: The maximum amount the label should be willing to spend to conduct the survey would be 50,000.

8. Regardless of prior answers, suppose the record label did the research and the results predicted success. What is the maximum amount it would then be willing to pay MII for its enhanced information?

Answer: The maximum amount it would then be willing to pay MII for its enhanced information would be EVSI of survey prediction as success is 40,000. So, the maximum amount it would then be willing to pay MII for its enhanced information would be 40,000.

9. For what range of profit, given success, is the market survey of any value?

Answer: If given success, we would know that the EMV would be 0.3*400,000 without the market survey, which is 120,000. With the condition of P (Success | Survey predicts success), the EMV will be 0.6*400,000 = 240,000. So yes, the market survey is very valuable, and the value is about 120,000 dollars. And for the market survey has any value, the profit would need to be over 120,000.