Posted: August 12th, 2015

110 CHAPTER 3 0 DECISION ANALYSIS

110 CHAPTER 3 0 DECISION ANALYSIS
information 18.1101 favorable, the probability of a suc- MONETARY
cessful store 18 only 0.2. Without any information, VALUE UTILITY
Sue estimates that the probability of a successful
store will be 0.6. A successful store will give a re- $100900 1
turn of $ loo,000. If the store is built but is not suc- 330-000 0-4
cessful, Sue will see a loss of $80,000. Of course, $0 02
she could always decide not to build the retail store. $20,000 0.1
(a) What do you recommend?
(b) What impact would a 0.7 probability of obtain- 480”)” 0’05
ing favorable information have on Sue’s deci- 4100000 0
sion? The probability of obtaining unfavorable
information would be 0.3. (f) Compute the expected utility given the following
(c) Sue believes that the probabilities of a successful utility table. Does this utility table represent a
and an unsuccessful retail store given favorable risk seeker or a risk avoider?
information might be 0.8 and 0.2, respectively,
instead of 0.9 and 0. l , respectively. What impact, MONETARY
if any, would this have on Sue’s decision and the VALUE UTILITY
best EMV? $100,000 1
(d) Sue had to pay $20,000 to get information. Would
$80,000 0.9
her deeismn change if the cost of the information
increased to $30,000? $0 0-8
(e) Using the data in this problem and the following -$20,000 0.6
utility table, compute the expected utility. Is this -$80.000 0.4
the curve of a risk seeker or a risk avmder‘? $100,000 0
Internet Homework Problems
See our Internet home page, at v. “Whpeitrsonltigliert-tl.t’tim/rt‘ntlet‘, for additional homework
problems, Problems 3-53 to 3-5 8.
Case Study
Startlng nght Corporation
After watching a movie about a young woman who quit a food would be frozen. This would allow for natural ingredients,
successful corporate career to start her own baby food com- no preservatives, and outstanding nutrition.
pany, Julia Day decided that she wanted to do the same. In Getting good people to work for the new company was
the movie, the baby food company was very successful. Julia also important. Julia decided to find people with experience
knew, however, that it is much easier to make a movie about in finance, marketing, and production to get involved with
a successful woman starting her own company than to actu- Starting Right. With her enthusiasm and charisma, Julia was
ally do it. The product had to be of the highest quality, and able to find such a group. Their first step was to develop
Julia had to get the best people involved to launch the new prototypes of the new frozen baby food and to perform a
company. Julia resigned from her job and launched her new small pilot test of the new product. The pilot test received
companywStaiting Right. rave reviews.

Julia decided to target the upper end of the baby food mar- The final key to getting the young company off to a good
ket by producing baby food that contained no preservatives but start was to raise funds. Three options were considered: corpo-
had a great taste. Although the price would be slightly higher rate bonds, preferred stock, and common stock. Julia decided
than for existing baby food, Julia believed that parents would be that each investment should be in blocks of $30,000. Further-
willing to pay more for a high-quality baby food. Instead of put- more, each investor should have an annual income of at least
ting baby food in jars, which would require preservatives to sta- $40,000 and a net worth of $100,000 to be eligible to invest in
bilize the food, Julia decided to try a new approach. The baby Starting Right. Corporate bonds would return 13% per year for