Question 5.5: Zeta Computing Services Ltd has recently produced some softw...
Zeta Computing Services Ltd has recently produced some software for a client organisation. The software has a life of two years and will then become obsolete. The cost of developing the software was £60,000. The client organisation has agreed to pay a licence fee of £80,000 a year for the software if it is used in only one of its two divisions and £120,000 a year if it is used in both of its divisions. The client may use the software for either one or two years in either division but will definitely use it in at least one division in each of the two years.
Zeta Computing Services Ltd believes there is a 0.6 chance that the licence fee received in any one year will be £80,000 and a 0.4 chance that it will be £120,000.
Produce an event tree diagram for the project.
The four possible outcomes attached to this project and their probability of occurrence (p) are as follows:
| Outcome | Probability | |
| 1 | Year 1 cash flow £80,000 (p = 0.6) and Year 2 cash flow £80,000 (p = 0.6). The probability of both years having cash flows of £80,000 will be (0.6 × 0.6). | 0.36 |
| 2 | Year 1 cash flow £120,000 (p = 0.4) and Year 2 cash flow £120,000 (p = 0.4). The probability of both years having cash flows of £120,000 will be (0.4 × 0.4). | 0.16 |
| 3 | Year 1 cash flow £120,000 (p = 0.4) and Year 2 cash flow £80,000 (p = 0.6). The probability of this sequence of cash flows occurring will be (0.4 × 0.6). | 0.24 |
| 4 | Year 1 cash flow £80,000 (p = 0.6) and Year 2 cash flow £120,000 (p = 0.4). The probability of this sequence of cash flows occurring will be (0.6 × 0.4). | 0.24 |
| 1.00 |
This information can be displayed in the form of an event tree diagram, as shown in Figure 5.11.
