A manufacturer of high-tech computing equipment must decide whether or not to continue development of a new promising technology. Continuing the development would cost $2 Million. If the development is continued, then a patent is either awarded or not. The best estimate is that there is a 70% chance that the patent will be awarded and a 30% chance that it will not. If the patent is awarded, the company needs to decide whether or not to license the technology. If it does, it would receive a total of $25 million in licensing royalties. However, the company could also produce and sell the technology in-house (at a cost of $10 Million), in which case there is an additional uncertainty about the demand for the technology. If the demand is high (p = 0.25), the company would make $55 Million in revenues, if the demand is medium (p = 0.55) the company would make $33 Million and if the demand is low (p = 0.20) the company would still make $15 Million.
a) Draw and solve a decision tree for this situation, assuming that the decision maker is risk neutral. Should the company continue the development of the technology and should it license it or produce it in-house in case a patent is awarded? (15 Points)
b) What is the maximum amount of money a risk-neutral decision maker should be willing pay to get more information about whether or not the patent will be awarded?

Question

23-11-2022
English

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A manufacturer of high-tech computing equipment must decide whether or not to continue development of a new promising technology. Continuing the development would cost $2 Million. If the development is continued, then a patent is either awarded or not. The best estimate is that there is a 70% chance that the patent will be awarded and a 30% chance that it will not. If the patent is awarded, the company needs to decide whether or not to license the technology. If it does, it would receive a total of $25 million in licensing royalties. However, the company could also produce and sell the technology in-house (at a cost of $10 Million), in which case there is an additional uncertainty about the demand for the technology. If the demand is high (p = 0.25), the company would make $55 Million in revenues, if the demand is medium (p = 0.55) the company would make $33 Million and if the demand is low (p = 0.20) the company would still make $15 Million.
a) Draw and solve a decision tree for this situation, assuming that the decision maker is risk neutral. Should the company continue the development of the technology and should it license it or produce it in-house in case a patent is awarded? (15 Points)
b) What is the maximum amount of money a risk-neutral decision maker should be willing pay to get more information about whether or not the patent will be awarded?

Answer :

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fawadmohd fawadmohd · Answer 1 · 2022-11-26T22:53:15-05:00

The amount that the Orange Company can capitalize as the cost of the patent is $2 million.

a) Data and Calculations:

Patent research and development costs = $12 million

Legal fees to secure the patent = $2 millioTotal patent cost = $14 million ($12 million + $2 millionAllowable capitalization cost = $2 million

b) Capitalization cost of the patent:

Only legal fees incurred to register or defend an internally developed patent are allowed to be capitalized. The research and development costs of an internally developed patent cannot be capitalized, but are recorded as expenses when incurred. However, Orange Company may capitalize the cost of the acquired patent and its legal fees.

To learn more about Capitalization please click on below link

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