Question

You have been tasked with choosing the direction of new growth for your company. You can enter the European market or concentrate on domestic growth. The company is banking on a patent approval which appears to be 50% likely to occur. In addition, if domestic is chosen, a new agreement is pending with the labor union, while it is likely to go through, there is a 20% chance it will not (causing additional costs). Finally, entering the European market bears additional risk of Putin going off his prescribed medication and invading the country your operation will be located. Currently, this is 10% likely.

The following profits would result:

- Patent approved, Putin behaves: $600,000

- Patent declined, Putin behaves: $200,000

- Patent approved, Putin breaks bad: -$50,000

- Patent declined, Putin breaks bad: -$750,000

- Patent approved, contract approved $500,000

- Patent declined, Contract approved : $250,000

- Patent approved, Contract declined: $400,000

- Patent declined, Contract declined: -$550,000

Construct a decision tree and determine the expected value of each choice. Which is higher? Which would be selected by a Risk Averse manager? Risk Neutral? Risk Seeking?

Answer 1