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Exercises 171
failing to meet the pollution standards the entire project would
be abandoned.
Assuming that Casti’s objective is to maximize expected net
savings (i.e. gross savings minus development costs) determine the
policy that the company should pursue (for simplicity you should
ignore time preferences for money).
(8) The Roka-Rola drinks company is engaged in continuous competition
for market share with its rival Tepsi. Recent technological
developments have led to the possibility of Roka-Rola including
a device in its cans which instantly cools the drink when the can
is opened. However, incorporating the device would be expensive
and the company must decide now whether or not to go ahead
with the development. Because of other competing demands on the
company’s capital, a decision not to go ahead now could not be
easily reversed.
If Roka-Rola does not incorporate the device then there is thought
to be only a 0.4 probability that Tepsi will include it in its cans.
If Tepsi does include it in an attempt to steal a march on Roka-
Rola then Roka-Rola would consider defending its position by
making some changes to the ingredients in the drink in an attempt
to improve its flavor, though this would be a risky strategy. A
decision not to change the ingredients would mean that there was
a 0.8 probability that Roka-Rola’s market share would fall to only
10% within a year and a 0.2 probability that it would fall to 20%.
A decision to change the ingredients would lead to a 0.3 risk of
only a 5% market share being achieved, but a 0.7 probability that
the market share would reach 30% in a year’s time. Changing the
ingredients would only be considered if Tepsi included the device
in its cans. If Tepsi, like Roka-Rola, did not incorporate the device
then it is thought to be virtually certain that Roka-Rola’s existing
market share of 25% will be maintained.
If a decision was made by Roka-Rola to incorporate the device
in its cans then there is thought to be a 0.7 probability that Tepsi
would retaliate and include a device in its own cans. If they did
not, then there would be a 0.2 probability of Roka-Rola achieving
a 40% market share by the end of the year and a 0.8 probability
that it would achieve a 50% market share. If Tepsi did retaliate then
Roka-Rola would have to consider changing the ingredients of the
product. A decision to change the ingredients would, it is thought,
be certain to leave Roka-Rola’s market share unchanged at 25%.
However, changing the ingredients would lead to a 0.7 probability