This problem can be solved by comparing the Expected Monetary Value (EMV) of the two options: launching with research vs. launching without research.
Step 1: Calculate the EMV of launching WITHOUT research.
The potential outcomes are success (profit) or failure (loss of launch cost).
- Value of Success = +$3,000,000
- Value of Failure = -$2,000,000
- Probability of Success = 40% or 0.4
- Probability of Failure = 100% - 40% = 60% or 0.6
EMV = (Value of Success × P(Success)) + (Value of Failure × P(Failure))
EMV = ($3,000,000 × 0.4) + (-$2,000,000 × 0.6)
EMV = $1,200,000 - $1,200,000
EMV without research = $0
Step 2: Calculate the EMV of launching WITH research.
First, account for the definite cost of the research. Then, calculate the EMV of the launch decision with the improved probabilities.
- Cost of Research = -$50,000
- Value of Success = +$3,000,000
- Value of Failure = -$2,000,000
- New Probability of Success = 75% or 0.75
- New Probability of Failure = 100% - 75% = 25% or 0.25
EMV of launch decision = ($3,000,000 × 0.75) + (-$2,000,000 × 0.25)
EMV of launch decision = $2,250,000 - $500,000 = $1,750,000
Now, subtract the cost of the research to find the total EMV for this option:
Total EMV = $1,750,000 - $50,000
Total EMV with research = $1,650,000
Step 3: Conclusion & Evaluation.
- EMV without research = $0
- EMV with research = $1,650,000
Comparing the two expected values, undertaking the market research leads to a much higher expected financial outcome ($1,650,000 vs $0). The $50,000 investment in research is justified because it significantly reduces the risk of failure and increases the potential financial return by $1,650,000. Therefore, the firm should conduct the market research.