Example 7 A firm is planning to develop and market a new drug. The cost of extensive research to develop the drug has been estimated at Rs. 100000. The manager of the Research programme has found that there is a 60% chance that the drug will be developed successfully. The market potential has teen assessed as follows: Market condition Prob. Present value of profit (Rs.) Large Market potentiat Ot 50,000 Moderate Market potential 0.6 25,000 Low Market potential 03 10,000 The present value figures do not include the cost of research. While the firm is considering this proposal, a second proposal almost similar comes up for consideration. The second ene also requires an investment of Rs.1,00,000 but the present value of all profits is 12,000. The return on investment in the second proposal is certain. @ Drawa decision tree indicating all events and choices of the firm. (i) What decision the firm should take regarding the investment of Rs. 1,00,0007Solution PV of Profit Re, 50,000 Ris. 25,000 Rs. 10,000 Fig.1 Decision Tree At Point D, Decisions are (1) Enter market (2) Do not enter market. @ Enter market : EMV =ExpectedP V = (70000 x 1) +(25000 x -&) + (.0000x,3) =5000+ 15000+ 3000 =23000 (b) Do not enter market EMV=Expected PV =0 x 1=0 Decision: Enter the market since EMV is more. AtD, Decisions are (1) Develop new drug (2) Accept proposal II {a) Develop new drug EMV = Expected PV = (23000 x .6)+(0 x 4)= (13800 +0)=13800 (b) Accept Proposal IT EMV = Expected PV = 12000 x 1 = 12000 Using EMV criterion, the optimal decision at D, is to develop and narket the new drug,