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CMA Final · Strategic Cost Management · Decision Making using Probability

A firm believes a new product has a 0.4 probability of success. A market survey gives a favourable report with probability 0.8 if the product will succeed and 0.3 if it will fail. Launching yields ₹500 thousand profit on success and a ₹200 thousand loss on failure. After a favourable survey report, what is the expected value of launching?

The expected value of launching after a favourable report is ₹248 thousand. Bayes' revision gives a posterior success probability of 0.32 divided by 0.50, which is 0.64. The expected value is then 0.64 times 500 less 0.36 times 200, which equals 248.

  1. A₹80 thousand
  2. B₹248 thousandCorrect
  3. C₹360 thousand
  4. D₹24 thousand

Explanation

P(favourable) = 0.4×0.8 + 0.6×0.3 = 0.32 + 0.18 = 0.50. Revised P(success | favourable) = 0.32/0.50 = 0.64. EV = 0.64×500 − 0.36×200 = 320 − 72 = 248. Using the prior 0.4 gives only 80, ignoring the survey information.

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