Question

Global Studios is thinking of producing a megafilm, Aqua World, which could be a megahit or a megaflop. Profit is uncertain for two reasons: (1) the cost of producing the film may be low or high, and (2) the market reception for the film may be strong or weak. There is a .5 chance of low costs (C) and a .5 chance of high costs. The probability of strong demand (D) is .4; the probability of weak demand is .6. The studio’s profits (in millions of dollars) for the four possible outcomes are shown in the table.

LOW C / STRONG D	LOW C / WEAK D	HIGH C/ STRONG 4	HIGH C / WEAK D
80	10	0	-70

a.Should the studio produce the film? Use a decision tree to justify your answer.

Answer 1

		Costs
	Low		High
		0.5	0.5
	Demand
	Strong	Weak	Strong	Weak
	0.4	0.6	0.4	0.6
Profits in $ Mlns.	80	10	0	-70
Individual outcome	16	3	0	-21
Expected profits	-2
(Sum of Individual probable outcomes)

Expected profits (in $ mlns.)=

(80*0.5*0.4)+(10*0.5*0.6)+(0*0.5*0.4)+(-70*0.5*0.6)=

-2

ANSWER:

a. NO

As the probable/expected profit is NEGATIVE.