Photstat Inc. is contemplating the formation of a project
team to develop a new service. Briefl y, the service would
allow customers to order customized mouse pads over the
Internet based on photographs or other artwork sent electronically to the firm.
The company estimates that the price of the mouse
pad will be between$ 10 and $ 15 per unit, with all prices
in this range equally likely. Based on historical data,
Photstat estimates that the total market size for these
types of products in their fi rst year follows a normal distribution with a mean of 100,000 units and a standard
deviation of 10,000. Again, according to historical data,
Photstat ’ s market share tends to be normally distributed
with a mean of 30 percent and standard deviation of 3
percent. Market growth tends to follow a normal distribution growing an average of 10 percent per year with a
standard deviation of 3 percent. Estimates from the equipment manufacturer selected to design and produce the
required equipment indicate that the cost of the equipment is normally distributed with a mean of$ 500,000
and a standard deviation of 60,000. Historical data indicate there is a 10 percent chance that the equipment will
last for only three years. Similarly, there is a 60 percent
chance the equipment will last six years, a 20 percent
chance it will last eight years, and a 10 percent chance
the equipment will last 10 years. The variable costs of
similar products were found to be normally distributed
with a mean of$ 3 and a standard deviation of$ 0.25.
Finally, an economic analysis undertaken by the fi rm suggests that the rate of infl ation in any given year is normally distributed with a mean of 3 percent and a standard
deviation of 0.5 percent.
QUESTIONS
1. What is the expected value of the project?
2. Simulate this project 1000 times and compute the average profi t over the 1000 replications. Plot a histogram
of the outcomes of the 1000 replications.
3. How does the average of the simulation compare to
the expected value you calculated? What are the managerial implications of this difference?