Question

considering making a new product. the probability that the new product is successful is 0.75. if it is successful it will generate $240,000 in revenue. if it is not successful it will not generate any revenue. the cost to develop the product is $196,000. use profit (revenue - cost) and expected value to decide if the company should make this product.
which of the following did your solution include?
p = $240,000 - $196,000 = $44,000
the expected value is a weighted average of each possible value weighted by its probability.
ev = ($44,000)(0.75)+($ - 196,000)(0.25) = $ - 16,000
the expected average profit is $ - 16,000
the company should not make the product

Explanation:

Step1: Calculate profit if successful

If successful, revenue is $240,000 and cost is $196,000. So profit $P = 240000 - 196000=\$44000$.

Step2: Calculate expected - value formula

The expected value $EV$ is a weighted average of each possible value weighted by its probability. The probability of success $p_1 = 0.75$ with profit $P_1 = 44000$ and probability of failure $p_2=0.25$ with profit $P_2=- 196000$ (negative because it's a cost). So $EV=(44000)\times(0.75)+(-196000)\times(0.25)$.

Step3: Calculate expected - value

$EV=(44000)\times(0.75)+(-196000)\times(0.25)=33000 - 49000=-\$16000$.

Step4: Make a decision

Since the expected average profit is $-\$16000$, the company should not make the product.

Answer:

$P = \$240,000-\$196,000=\$44,000$; The expected value is a weighted average of each possible value weighted by its probability; $EV = (\$44,000)(0.75)+(\$-196,000)(0.25)=\$-16,000$; The expect average profit is $\$-16,000$; The company should not make the product.