Shayan is considering producing a new innovative chair design at his manufacturing facility but is unsure about market demand. There is a 40% chance the market will be large, allowing him to sell 8,000 chairs and make Rs. 800,000, or a 60% chance the market will be small with sales of only 1,000 chairs and Rs. 100,000 profit. Hiring a market research firm to evaluate demand could resolve this uncertainty but would cost Rs. 50,000.

1. SHAYAN’S INNOVATIVE CHAIR PRODUCTION DECISION
Shayan Shahid runs a small company that manufactures low-cost chairs, sold via the Internet.
His firm has several popular models, each with annual sales of Rs. 200,000 to Rs. 450,000. His
research staff has produced a prototype that improves on the top-of-the-line model in several
ways. However, because of the number of innovations in the new chair, Shayan does not expect
to be able to produce it using the existing manufacturing facility. Shayan knows that a new
facility will cost Rs 300,000 and is unsure whether there will be sufficient demand for the chair
to cover the large investment. If the market is good, He thinks he might sell 8000 chairs at a
profit of Rs.100 each, generating a cash flow with present value of Rs. 800,000. On the other
hand, if the market is poor, he thinks he might sell only 1000 chairs, generating a cash flow with
present value of only Rs. 100,000. A recent research finding for the chair industry has revealed
that the probability of a large market is less than half if a manufacturer risks in producing an
innovative chair. Shayan is considering a 40% chance for the market to be large.
(i) How should he make his decision?
Suppose there is a chance that the innovative and controversial chairs will be shown on national
television. This will increase sales fourfold: that is, to Rs. 3.2 million if the market is large and to
Rs. 400,000 if the market is small. Shayan estimates that the chance of his product’s being
featured on TV is 10% if the market is large and only 1% if the market is small.
(ii) What is the value of the decision now?
A major problem for Shayan in the whole analysis is that how to be certain about whether the
market is going to be large or small if he ventures to go for production of his new innovative
chair model. A market research firm named ‘Beta Consultants’ have the ability to do this job for
Shayan’s most pressing question. Beta consultants are requested to submit a proposal to evaluate
the potential market for the chair. Shayan is confident that this will resolve his uncertainty about
whether the market for the chair will be small or large. Beta Consultants are going to charge Rs.
50,000 for the survey research.
(iii) Should he take this decision?