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The financial director of Spinney Electronics is considering the national launch of a new washing

machine. The potential sales of the product during its lifetime are classified as being either high,

medium or low and the net present value of the machine sales under each of these three conditions

is estimated to be sh50 million, sh10million and sh20 million respectively. The marketing director

estimates that there is a 0.4 probability that sales will be high, 0.25 probability that they will be

medium and a 0.35 probability that they will be low.

Required:

a) Assuming the company’s objective is to maximize expected NPV, determine whether or

not the new product should be launched. (4 marks)

b) Explain the meaning of ‘expected value of perfect information’. Find the expected value

of perfect information for this situation. (5 marks)

c) The financial director also has an alternative solution. Instead of proceeding directly

with a full national launch the company could test the market for the washing machine

in their Midlands sales region. This would delay the national launch, and this delay,

together with other outlays associated with testing the market, would lead to costs

having a net present value of sh0.25 million. The test marketing in the Midlands sales

region would yield information indicating whether the national launch is likely to be

successful or unsuccessful. The following table shows the reliability of each of the

possible indications.

Actual national sales

Probability High Medium Low

Test marketing indication

Successful 0.6 0.6 0.15 0.25

Unsuccessful launch 0.4 0.1 0.4 0.5

For example

If the market indicates a successful launch, then the probability of low sales will be 0.25. Also

prior to the test market it is thought that the test market has a probability of 0.6 of indicating a

successful launch and of 0.4 for an unsuccessful launch.

i. Represent this information in a decision tree and calculate the value of this imperfect

information. (7 marks)

ii. Give advice to the financial director as to whether or not the company should test the

market in their Midlands region. In your advice, explain why this method of analysis

should not be relied upon entirely when making appropriate decision. (4 marks)

(20mks)