Question

a company is considering making a new product. they estimate the probability that the new product will be successful is 0.75. if it is successful it would generate $240,000 in revenue. if it is not successful, it would not generate any revenue. the cost to develop the product is $196,000. use the profit (revenue - cost) and expected value to decide whether the company should make this new product.

Explanation:

Step1: Calculate expected revenue

The probability of success $P(S)=0.75$, and revenue if successful $R = 240000$, probability of failure $P(F)=1 - 0.75=0.25$ and revenue if failed $R_{F}=0$. The expected - revenue $E(R)$ is calculated as $E(R)=P(S)\times R+P(F)\times R_{F}$.
$E(R)=0.75\times240000 + 0.25\times0=180000$.

Step2: Calculate expected profit

The cost to develop the product $C = 196000$. The expected profit $E(P)$ is $E(P)=E(R)-C$.
$E(P)=180000 - 196000=- 16000$.

Answer:

The company should not make this new product since the expected profit is -$16000$.