Question

A small company has developed a new product for the electronics industry. The company believes that an advertising campaign costing R2000 would give the product a 70% chance of success. It estimates that a product with this advertising support would provide a return of R11000 if successful and return of R2000 if it not successful. Past experience suggests that without advertising support a new product of this kind would have a 50% chance of success giving a return of R10000 if successful and a return of R1500 if not successful. Construct a decision tree and write a report advising the company on its best course of action.

Answer 1

Answer on Question #42698, Economics, Finance

TCa = R2000, 70% chance of success.

TR = R11000 if successful, TR = R2000 if it not successful.

Without advertising - 50% chance of success, TR = R10000 if successful, TR = R1500 if not successful.

A decision tree is a decision support tool that uses a tree-like graph or model of decisions and their possible consequences, including chance event outcomes, resource costs, and utility. It is one way to display an algorithm.

(70%) revenue R11000
/
with advertising
/ (cost R2000) \
/ (30%) revenue R2000
Decision tree
\ (50%) revenue R10000
\ /
without advertising
\ (50%) revenue R1500

Using provided probabilities and forecasted returns, we can calculate weighted returns:

TR (with advertising) = -2000 + 0.7*11000 + 0.3*2000 = R6300

TR (without advertising) = 0.5*10000 + 0.5*1500 = R5750

So, we advise the company to use advertising program in order to have higher returns.

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