Question

Consider the following two projects:

Project, one has an initial cost of $100,000 and expected return of $500,000 with a probability of success of 0.95

Project two has an initial cost of $100,000 and expected return of $550,000 with a probability of success of 0.85

Which project should you choose? Show your work.

Answer 1

Let's first calculate the expected value of the two projects and then compare the two based on expected value:

Expected Value or profit from Project 1 = ( Probability of success * Expected return) - Initial Cost

Expected value from project 1 = (0.95 * 500,000) - 100,000 = $375,000

Expected value or profit from Project 2 = (Probability of success * Expected return) - Initial Cost

Expected profit from Project 2 = (0.85 * 550,000) - 100,000 = $367,500

We can see that the expected value of Project 2 > Expected value of Project 1.

Thus, We should choose project 2 over project 1.