Author:
Christine Farr

Use the following information to answer the next six questions. (To answer these questions, you will want to construct a decision tree showing Monica's options and payouts and probabilities.}

Monica wants to begin a toy sailboat business and because of the expense involved in developing molds and acquiring the necessary equipment, wants to conduct a market study to see if the market is adequate to support her business. The study will cost $10,000 and can be either favorable or unfavorable. Her basic decision is to build a small or large shop or no shop at all. Expected profits are shown in the table below. Monica estimates that the probability of a favorable market given a favorable market study is 0.8. The probability of an unfavorable market given an unfavorable market study is estimated to be 0.9. (Thus, the probability of an unfavorable market given a favorable market study is 0.2 and the probability of a favorable market given an unfavorable market study is 0.1.) Monica feels that there is a 50-50 chance that the market study will be favorable. Of course, Monica could bypass the market study and simply make the decision. If she did no study, she estimates that the probability of a favorable market is 0.6. Monica's expected profits are shown in the following table:

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