HW #1 solutions - AEM 424 HW#1 Decision Tree Solutions...

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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 increase to $750,000. Use the same procedure to see this.
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Part b.
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