13 May WHAT IS THE MAXIMUM THE GOVERNMENT SHOULD PAY FOR THE PILOT TEST?
Value of Information The government has spent $1000 million on
developing a new aircraft which is suitable for only one route.
Unfortunately the aircraft is rather noisy and is in danger of
being refused landing rights on this route. There are two possible
courses of action: the government can apply for rights now, or it
can commission further investment in an attempt to make the engines
quieter before an application is submitted. There is no possibility
of applying for rights more than once since if they are refused,
the political situation will be such that the decision will not be
reversed. The research and development to make the engines quieter
would cost $100 million, and the current estimate of the
probability of success is 0.7. Before embarking on this further
project, the government can carry a pilot project for $10 million.
The report of the pilot project would indicate that, for $100
million, either the quiet engines are certain or they are unlikely.
The engineers on the project are biased toward aircraft
development, so the government estimates that even if the large
project will fail to produce quieter engines, there is still a
probability of 0.3 of the pilot project report saying that they are
certain. If the larger project will in fact succeed, the pilot
project is certain to indicate this. If the pilot project indicates
that success is unlikely, then the government will not proceed with
the main project and will apply for landing rights with the
existing engines. If the pilot project report is favorable, the
government will proceed with the larger project. If the quiet
engines are successfully developed, landing rights are certain. If
they are not developed, there is only a 50:50 chance of receiving
rights. With either quiet or noisy engines, the present worth of
operating profits is $300 million. 1.0 – What should the government
do? 2.0 – What is the maximum the government should pay for the
pilot test? 3.0 – Provide a decision tree and an influence
diagram
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