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daniel uses a decision tree analysis to evaluate potential projects. The company has been looking at the launch of a new product which it believes has a 70 percent probability of success. The company is , however, considering undertaking an advertising campaign costing shs.500000 which would increase the probability of success to 95 percent. If successful the product would generate income of shs. 200000 otherwise shs. 70000 would be received. what is the maximum that the company would be prepared to pay for the advertising?
Without the advertising the expected profit is (0.70 x 200,000) + (0.3 x 70,000) = $161,000
With the advertising the expected profit is (0.95 x 200,000) + (0.05 x 70,000) = $193,500
Therefore the most they will pay for advertising is 193,500 – 161,000 = $32,500.
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