Case #2

More and more, people are using energy drinks as a quick pick-me-up during the day.
These beverages, which are intended to energize the consumer and are known to aid
alertness, usually contain caffeine or taurine in addition to herbal ingredients, such as
ginseng, and various vitamins and minerals. The market is extremely competitive.

Diet Coke is contemplating introduction of a new energy drink and a new brand of root
beer. We will analysis each decision separately. First we consider analysis of their
decision regarding the new energy drink. The company estimates that in case they
produce the new energy drink it will yield a profit of $1,000,000 if sales turn out to be
around 100,000,000 bottles, a profit of $200,000 if sales turn out to be 50,000,000
bottles, or they will lose $2,000,000 if sales turn out to be around 1,000,000 bottles. If
Diet Coke doesn’t produce the new energy drinks, they will suffer a loss of $400,000.
 a. Decision tree:

b. Payoff table

Numbers of payoff table Profit made Profit margin per bottle

100,000,000 1,000,000 0.01
50,000,000 200,000 0.004
C. regret table

Number of bottles sold Loss made Loss per bottle

1,000,000 2,000,000 2
0 400,000 All loss

d. Explain in details and provide the appropriate arguments if Diet Coke introduce the new
energy drink by using:

If diet coke introduce the new energy drink then it may have profit of 0.01 /bottle or
0.004/bottle or -2/bottle . total profit /bottle is 1.986/bottle

I ) Conservative approach :

S1 S2 S3
N1 0.01 0.004 -2

There will be loss of 2000000 with 1000000 bottles

2) Optimistic approach: There will be the profit of 1000000 with 100000000 bottles

e. An internal study by the management estimates that the probability of selling

100,000,000 bottles is 0.3333, the probability of selling 50,000,000 bottles is 0.50, the
probability of selling 1,000,000 bottles is 0.1667. Should they introduce the new diet drink?
Why? Explain in details.

S1 S2 S3
Expected Payoff 0.3333*1000000 0.5*200000 0.1667*(–2000000)
=333300 =100000 = –333400
Overall profit 333300+100000–333400
=99900

As, overall there will be the profit of 99900 units they should introduce new diet drink. If they
will not introduce the new diet coke they have to suffer the loss of 400000 which is not
affordable. Average profit will be 99900/3 = 33300 units.
f. “Soft Drink Consultants” is a company that provides a tailor-made feasibility study for a
consulting fee of $275,000. Should Diet Coke hire them to conduct such study? Why?
Explain.

As overall profit is 99900 < consulting fees $ 275000, it’s not advisable to hire the consultancy.

a. After receiving such results, recommend an optimal decision for Diet Coke, assuming that
management believes that results of neither consulting firms’ are correct and their study
will NOT be used. Over what range of probability of success their decision is optimal?

Given that, p (I1 / S1) = 0.70 and P (I1 /S2) =0.40

And P (J1 /S1) +0.60 and P (J1 /S2) =0.30

P(I1/S1 )=(1-0.70)=0.30, P(I2/S2 )=1-0.40=0.60

P(J2 /S1 )=(1-0.60)=0.40, P(J2 /S2 )=1-0.30=0.70

So, probability of success their decision is optimal

= p(I1 /S1 ) P(J1 /S1 ) + P(I2 /S1 ) P(J2 /S1 )

=0.70*0.60 + 0.30*0.40
= 0.42 + 0.12
= 0.54

b. Calculate the EVPI

EMV= max ∑ p R
[(0.60*250,000) + 0.40 (-20,000)] $
=$ 192,000
So, EVPI = EVPI-EMV= 0

c. Calculate the EVSI and the efficiency for both consultants.

Expected value without sample without information

= (expected value of producing root beer, expected value of not producing root beer)

Expected value of producing root beer

= 0.6×250,000 – 0.4×300,000
= $30,000

Expected value of not producing root beer

=0.6×50,000 – 0.4×20,000
= - $ 38,000

Expected value without sample information

=Max [30,000 - 38000]
= 30,000

Given P(I1/S1) = 0.70

P(I2/S2) = 0.40

P(I2/S1) = 0.30 and P(S2) P(I1/S2)

= 0.6×0.7 + 0.4×0.4
= 0.58
P(I2)= 1-P(I1) = 1 – 0.58 = 0.42
P(S1/I1) = P(S1) P(I1/S1)÷p(I1)
= 0.6×0.7 ÷0.58
= 0.72
P(S2/I1) = 1 – 0.72 =0.28
P(S1/I2) = P(s1) P(I2/s1) ÷ P(I2)
= 0.6×0.3 ÷ 0.42 = 0.43

P(S2/I2) = 1 – 0.43 = 0.57

Expected value when both drink consultants recommends introduction of the new
product
=P(S1/I1)* ×250,0000) – P(S2/I1) × 300,000
= 0.728 250,000 – 0.28* 300,000
= 96,000

Expected value when both drink consultants do not recommends introduction of the
new product
= P(S1/I2) × (– 50,000) – P(S2/I2) × 20,000
= –0.43×50,000 – 0.57820,000
= –$32,900

Expected value with sample information

= P(I1) ×96,000 –P(I2) ×32,900
=0.38×96,000 –0.42×32,900
= $41,862
 EVSI for soft drink consultants = 41,862 –30,000
=11,862

Efficiency of soft drink consultants= p(S1/I1)=0.72

Given p(J1/S1)=0.60 and P(J2/S2)=0.30

P(J2/S1)=0.40 and P(J2/S2)= 0.70

P(J1)=P(S1)P(J1/S1)+(P(S2)P(J1/S2)

=0.6×0.6 + 0.4×3

=0.48

P(J2)= 1 –P(j1)= 1 –0.48=0.52

P(S1/J1)=P(S1)P(J1/S1)/P(J1)

=0.6×0.6/0.48=0.75

P(S2/J1)=1 –0.75=0.25

d. If both consultants charge $5,000, which firm should be hired and why?

If both consultant change $5,000, we should hire soft drink consultant as EVS1 of soft
drink consultant is larger than Innovation Research Inc.

e. If Soft Drink Consultants charges $10,000 and the “Innovative Research Inc.”
charges $4,000, which consulting firm should be used and why. Explain in details.

If soft drink consultants charges $10,000 and the Innovation Research Inc. charges
$4,000. Then,

Net EVSI for soft drink consultants = 11862-10,000

= $1862

Net EVSI for Innovative research Inc. = $6424-4000

= $2424

As, Net EVSI for Innovative Research Inc. is larger than that of soft drink Consultants,
We should hire Innovative research Inc.