Question

3.) Your firm has been sued for $3 million by a supplier for breach of contract. Your lawyers believe that there are three possible outcomes if the suit goes to trial. One, which the lawyers term “highly improbably,” is that your supplier will win the lawsuit and be awarded $3 million. Another, which the lawyer term “unlikely,” is that your supplier will win the lawsuit and be awarded $500,000. The third which the lawyers term “likely,” is that your supplier will lose and the lawsuit and be awarded $0. You have to decide whether to try to settle the case. To do so you need to assign probabilities to “highly improbable,” “unlikely” and “likely”. What probabilities correspond to these statements? Going to trial will cost you $100,000 in legal fees. One of your lawyers believes that your supplier will settle for $100,000 (and you will have legal fees of $25,000). Should you settle?

Answer 1

Option-1) Settling will cost $100,000 (settlement) + $25,000 (legal fees) = $125,000

Option-2) It will cost $100,000 in legal fees to go to trial.

It is not which probabilities go with what statement.

When P = 0.002; Highly improbable then the supplier gets $3 million

When P = 0.005; Unlikely then he wins $500,000

P = 0.01; Likely he will not get anything

Now: (125,000 / $3,000,000) = 4.17 %; and (125,000 / $500,000) = 25 %

Thus considering the above computations I would prefer to settle for $125,000