Question

You recently made a decision at work. The firm was in a difficult position and you had to choose between two unpleasant options. Option 1 had a 25% chance of success, which would have made the company $100,000 and a 75% chance of failure, which would have lost the company $300,000. Option 2 had a 10% chance of success, which would have made the company $600,000 and a 90% chance of failure, which would have lost the company $400,000. Using every possible piece of information available to you and the company at the time, you chose option 1. Unfortunately, the result was a failure so now you have an irate boss in your office claiming that you made the wrong choice and lost $300,000. Even worse, it looks like option 2 would have resulted in a success, so your boss is arguing you really lost almost one million dollars. Defend your decision and save your job! (Hint: Expected value is one piece of the answer here, but you’ll want a bit more than that for full credit)

Answer 1

Option 1 will definately be considered as a better option as compared to Option 2 because:

1. Expected value of loss in Option 1 (-2000000) is less than Expected value of loss in Option 2 (-3000000) arising from the decision tree attached in the answer.

2. Athought the the occurence of profit in Option 2 is 600000$ with a probability of 10%, but The occurence of loss in Option 2 is 400000$ with a probability of 90%, so if the loss would have occured, it would not only further detoriate the financial position of the firm, but also badly affect the goodwill and reputation of the firm.

3. Option 1 has only a deviation of 400000$ ( 100000- (-300000)) dollars as compared to deviation of 1000000$ ( 600000- (-400000)) dollars which indicates that Option 2 is much more riskier than Option 1.

Hence, I conclude that it was a right decision after noting the aforementioned points. Thank you.