Question

The next two questions are based on the following information.

Paul wants to choose one of the two investment opportunities over three possible scenarios. Investment 1 will yield a return of $10,000 in Scenario 1, $2,000 in Scenario 2, and a negative return of -$5,000 in Scenario 3. Investment 2 will yield a return of $6,000 in Scenario 1, $4,000 in Scenario 2, and zero in Scenario 3. The probability for Scenario 1 is 0.2, for Scenario 2 is 0.3, and for Scenario 3 is 0.5.

1.

you were to choose the investment that maximizes Paul's Expected Money Value (EMV), then you should choose __________.

1. Investment 1
2. Investment 2
3. Indifferent

2.

If Paul is uncertain about the return for Investment 1 in Scenario 1, then this return has to be ___________ dollars in order to make Paul indifferent between these two investments (i.e. the two investments would have the same EMV.) (Please only enter an integer and include no units.)

Answer 1

1) Statement showing Expected return on investment 1

Scenario	Return	Probability	Expected return = Return*Probability
1	10000	0.2	2000
2	2000	0.3	600
3	-5000	0.5	-2500
			100

Thus expected return = 100$

Statement showing Expected return on investment 2

Scenario	Return	Probability	Expected return = Return*Probability
1	6000	0.2	1200
2	4000	0.3	1200
3	0	0.5	0
			2400

Thus expected return =$2400

Thus Investment 2 should be selected

Ans B. Investment 2

2)

Let return in scenario 1 be X

Expected return = (X*0.2) + (2000*0.3) + (-5000*0.5)

=2400 = 0.2X + 600 -2500

=2400 = 0.2X -1900

4300 =0.2X

X =21500$

Thus Return in scenario 1 should be 21500$ to make Paul indifferent between these two investments