Question

Elaine Benes is considering three possible ways to invest the $200,000 she has just inherited.

Some of Elaine’s friends are considering financing a combined laundromat, video-game arcade, and pizzeria, where the young singles in the area can meet and play while doing their laundry. This venture is highly risky and could result in either a major loss or a substantial gain within a year. Elaine estimates that the chances of losing all the money (i.e. loss of $200,000) are 60%, while the chances of making a $200,000 profit are 40%.

Elaine can invest in some new apartments that are being built in town. Within 1 year, this fairly conservative project will produce a profit of at least $10,000, but it might yield $20,000 or even $30,000. Elaine estimates the probabilities of these yields at 20%, 50%, and 30% respectively.

Elaine can invest in some private securities that have a current yield of 8.25%.

Answer the following three questions -- create a file and upload.

A. Construct (draw) a decision tree for Elaine to determine which investment will maximize her expected 1- year profit.

B. How much should Elaine be willing to pay for perfect information about the success of the laundromat?

C. How much should Elaine be willing to pay for perfect information about the success of the apartments?

Answer 1

Answer A)

Answer B)

For the decission = $200,000 * 40% + 21000*60% = $92600

Value of perfect info = 92,600-21,000=71,600

Elaine should pay $71,600

Answer C)

the success of the apartments= $16,500 * 20%+20,000*50% + 30,000 * 30% = $22,300

Value of perfect Info = 22,300-21,000 = $1300

Elaine should pay $1,300