Question

A company looking for venture capitalist funding is deciding on the design of its operating system (OS) for its new phone. The first option is to simply buy the OS from another company. This would result in sales of either 10,000 units if the market is not crowded with similar phones, or sales of only 3,000 units if the market is crowded. If the company decides to design its own OS, the phone would have sales of 70,000 units if the OS was popular, but sales of only 2,000 if the OS was a failure. Suppose that to recoup the cost of designing their own OS the company would need to sell twice as many phones as when they simply buy the OS for the profit from the scenarios to be equal. Which option should the company choose if the probability that the market is crowded is 50% and the probability that the OS is popular is 75%?

please show work not excel

Answer 1

If the company buys the OS, then expected sales = Sales if market is not crowded * (1 - Probability that market is crowded) + Sales if market is crowded * Probability that market is crowded

= 10000*(1-0.5)+3000*0.5

= 6,500 units

If the company designs its own phone, then expected sales = Sales if OS is popular * Probability that OS is popular + Sales if OS not popular * (1 - Probability that OS is popular)

= 70000*0.75+2000*(1-0.75)

= 53,000 units

We see that expected sales in case of company designing its own OS is more than twice the sale in case of buying the OS.

Therefore, cost of designing is recouped.

Recommendation: the company should design its own OS