Question

The company that you manage has invested \(5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to \)3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

Short answer

The total cost involved in the project will be $6 million. The most that can be paid for the project's development will be not more than $3 million.

In such a situation, no one will go ahead with the project.

Step-by-step solution

 Total Cost involved in developing the new product

The cost initially invested, i.e., $5 million, cannot be recovered—an additional $1 million is required to finish the product's development. If the product development is stopped, then the entire investment will go in vain, i.e., the loss of $5 million. Thus, the total cost will be $5 million plus $1 million additional costs for developing the product, which is $6 million.

Decision

If the company invests more than $1 million, there will be a chance to recover the loss of $3 million. Thus, the total is $6 million, and the chance to earn is $ 3 million. Hence, the most that will be paid for the development of the product will be no more than $3 million as if the cost increases beyond $3 million; then the chance to earn profit will not be there.