AEM 424 HW#1
Decision Tree Solutions
Problem #1
a. See decision tree below. You have already developed the software, so that $2 million is a sunk cost (assuming you
can’t see the software). Forget about it. The expected value of marketing the software is
$3,350,000, which is
greater than the expected value of not marketing, which is $0. So, not knowing whether or not Linux will succeed,
the best you can do is to get $3,350,000 on average.
b. Now suppose you know whether or not Linux will succeed. If Linux does succeed, a situation you will face with
probability 0.7, you will chose to market with a profit of $5,000,000. If Linux does not succeed, a situation you will
face with probability 0.3, you will chose not to market with a payout of $0. So, on average, you will get
0.7($5,000,000)+0.3($0)=3,5000,000.
The value of knowing the information is thus the difference between the best you can do knowing and the best you
can do not knowing: $3,500,000-$3,350,000=$150,000.
If you could go back in time and reconsider the decision to develop the software, the value of the information would