Question

RedBird Games produces board games and has recently received a proposal for a new board game. The manager responsible for reviewing submitted board game proposals is quite familiar with the style of the game proposed and believes there's a 65% chance that the game will be successful. If successful, a profit of $750,000 can be expected. If RedBird Games decides to produce the proposed game and it is unsuccessful, a loss of $250,000 will occur. Before deciding to accept or reject the proposed board game, the manager has the option to send it out for review by experts that RedBird Games can hire. The review process will provide either a favorable (F) or unfavorable (U) evaluation of the proposed board game. RedBird Games' past experience with these expert reviewers suggests probabilities P(F)=0.7 and P(U)= 0.3 apply. Let Al represent that the proposed game is successful, and A2 be that the proposed game is unsuccessful. The manager's initial probabilities of A1 and A2 will be revised based on whether the review is favorable or unfavorable. The following probabilities are given. P(A1|F) = 0.75 P(A2|F) = 0.25 P(A1U) = 0.417 P(A2U) = 0.583 (a) Construct a decision tree assuming that RedBird Games will first make the decision of whether to send the proposed game out for review by experts and then make the decision to accept or reject the game. You may use PowerPoint to draw or draw on paper and take a picture to attach. Your attached picture must be clear and large enough to read. (7 points) (b) Analyze the decision tree to determine the optimal decision strategy for RedBird Games. Show the analysis and report the optimal decision strategy in a managerial statement. (7 points) @) If the proposed game review costs $5000, what is your recommendation? (3 points) (d) What is the expected value of perfect information? What does this EVPI suggest for the company? (3 points)

Answer 1

(a)

0.65 Success 750000 Accept the game 750000 750000 0 400000 0.35 Failure No review -250000 -250000 -250000 400000 Reject the game 0 0 0 0.75 Success 750000 Accept the game 750000 750000 400100 0 500000 0.25 Failure 0.7 Favorable -250000 -250000 -250000 0 500000 Reject the game 0 0 0 Review 0.417 Success 0 400100 750000 Accept the game 750000 750000 167000 0.583 Failure 0.3 Unfavorable -250000 -250000 -250000 0 167000 Reject the game 4 0 0

(b)

The optimal decision is to review first and then accept the game irrespective of the finding of the review.

(c)

The EVSI = 400100 - 400000 = $100 only. Paying $5,000 is not good because the worth of the review is only $100.

(d)

EVwPI = 0.65*Max(750000, 0) + 0.35*Max(-250000, 0) = 487500

EVwoPI = 400000

So, EVPI = EVwPI - EVwoPI = 487500 - 400000 = 87,500

This means that if 100% perfect information were available, the expected value would have increased by $87,500