Managerial Economics: A Problem Solving Approach
5th Edition
ISBN: 9781337106665
Author: Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher: Cengage Learning
expand_more
expand_more
format_list_bulleted
Question
Chapter 17, Problem 4MC
To determine
The expected
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
You are considering a $500,000 investment in the fast-food industry and have narrowed your choice to either a
McDonald's or a Penn Station East Coast Subs franchise. McDonald's indicates that, based on the location where you
are proposing to open a new restaurant, there is a 25 percent probability that aggregate 10-year profits (net of the
initial investment) will be $16 million, a 50 percent probability that profits will be $8 million, and a 25 percent
probability that profits will be -$1.6 million. The aggregate 10-year profit projections (net of the initial investment) for
a Penn Station East Coast Subs franchise is $48 million with a 2.5 percent probability, $8 million with a 95 percent
probability, and -$48 million with a 2.5 percent probability. Considering both the risk and expected profitability of
these two investment opportunities, which is the better investment? Explain carefully.
Suppose that you graduate from college next year and you have two career options: 1) You will start a job in an investment bank paying a $100,000 annual salary. 2) You will start a Ph.D. in economics and, as a student, you will receive a $20,000 salary. You are bad with decisions, so you are letting a friend of yours decide for you by flipping a coin. The probabilities of options 1 and 2 are, therefore, each 50%. a) Illustrate, using indifference curves, your preferences regarding consumption choices in the two different states of the world. Assume that you are risk-averse. [Include also the 45 degrees line in your figure] b) Now show how the indifference curves would change if you were substantially more risk averse than before. Explain. c) Now show the indifference curves if you are risk neutral and if you are risk loving. d) Show your expected utility preferences from point a) mathematically.
A drug company is considering investing $100 million today to bring a weight loss pill to the market. At the end of one year, the firm will know the payoff; there is a 0.50 probability that the pill will sell at a high price and generate $37 million per year of profit forever and a 0.50 probability that the pill will sell at a low price and generate $I million per year of profit forever. The interest rate is 10%. Suppose the firm decides to wait one year to determine whether the pill will sell at a high or low price. The firm will not invest if it learns that the pill will sell at a low price. What is the net present value of waiting one year to make the investment?O $88 millionO$122.72 millionO $201.22 millionO $64.5 million
Chapter 17 Solutions
Managerial Economics: A Problem Solving Approach
Knowledge Booster
Similar questions
- A drug company is considering investing $100 million today to bring a weight loss pill to the market. At the end of one year, the firm will know the payoff; there is a 0.50 probability that the pill will sell at a high price and generate $37 million per year of profit forever and a 0.50 probability that the pill will sell at a low price and generate $1 million per year of profit forever. The interest rate is 10%. Suppose the firm decides to wait one year to determine whether the pill will sell at a high or low price. The firm will not invest if it learns that the pill will sell at a low price. What is the net present value of waiting one year to make the investment? $107.44 million $64.5 million $201.22 million $88 millionarrow_forwardSuppose that you have two opportunities to invest $1M. The first will increase the amount invested by 50% with a probability of 0.6 or decrease it with a probability of 0.4. The second will increase it by 5% for certain. You wish to split the $1M between the two opportunities. Let x be the amount invested in the first opportunity with (1-x) invested in the second. Find the optimal value of x. Using expected value as the criterion (linear utility) Using the flowing utility function: u(x)=2.3 ln〖(1+4.5x)arrow_forwardSuppose you have a house worth $200,000 (wealth). Your utility of wealth is given by U(w) = ln(w). There is a small chance that a fire will damage your house causing a loss of $75,000. You estimate there is a 2% chance of fire. a) What is your expected wealth? b) What is your expected utility from owning the house? c) Suppose you can add a fire detection/prevention system to your house. This would reduce the chance of a bad event to 0 but it would cost you $C to install. What is the most you are willing to pay for the security system? (Here is an identity you will find usefularrow_forward
- You take a position with a large real estate development company as your first job after graduation. Your first big assignment is to sell an office building – you have been informed the company’s cost into the building (and the bottom line price it is willing to accept) is $400,000. You have identified a likely buyer and you assess that his top price is either $500,000 with a probability of .3, $600,000 with a probability of .5, or $1,000,000 with a probability of .2. You have to commit to a posted price – what price will maximize your profitability?arrow_forwardPriyanka has an income of £90,000 and is a von Neumann-Morgenstern expected utility maximiser with von Neumann-Morgenstern utility index u(x) = square root x . There is a 1 % probability that there is flooding damage at her house. The repair of the damage would cost £80,000 which would reduce the income to £10,000. a) Would Priyanka be willing to spend £500 to purchase an insurance policy that would fully insure her against this loss? Explainarrow_forwardthe video link is: https://www.youtube.com/watch?v=aqEz6kvXhc8please give me detailed solutions and calculations, thank you!arrow_forward
- Answer all questions. Imagine you are a person with a chronic disease. If the disease flares up, you will have to take substantial leave from work. The probability of the flare-up is 0.2 (or 20%). If you do not need to take leave from work, your income is $6400. If you take leave from work, your income is $1600. What is the expected value of your income? Expected utility E [= (U(1)] = pU (IS) + (1-p) U (IH) 1600 x 0.2 + 0.8 x 6400 = 5540 Assume that your utility function . What is the expected utility of your income? 0.8 √ 6400 + 0.2 √1600 = 72 utils Suppose a company is offering insurance where your premium is $500 and your payout is $2000. What is your expected utility from taking on this insurance? (Hint: you need to calculate your adjusted earnings in both states)arrow_forwardSuppose you have an exponential utility function given by U(x) =1- exp(-x/R) where, for you, R = 1000. Further, suppose you have an investment with a 50/50 chance of returning either 0 or 2000 dollars. Note U(0) = 0 and U(2000) = 0.865, so the utility of the lottery is 0.432. What is the certain equivalent of that investment?arrow_forwardLukas is a risk-averse farmer. He grows barley on his 1000 acre farm. In a typical year his farm yields 100 bushels of barley per acre. However, in a wet season, the farm only yields 40 bushels per acre. The probability of a typical season is 0.8 and of a wet season is 0.2. Regardless of the productivity of his farm, he expects to earn $3 per bushel (net of all costs of farming). Assume that Lukas has no other income. Write an expression for Lukas's expected utility.arrow_forward
- Asaparrow_forwardQUESTION 2 An expected utility maximiser owns a car worth £60 000 and has a bank account with £20 000. The money in the bank is safe, but there is a 50% probability that the car will be stolen. The utility of wealth for the agent is u(y) = In(3) and they have no other assets. A risk-neutral insurance company is willing to insure the car at the premium of 7 = £2/3 for every one pound of coverage. How much insurance coverage will the individual choose to buy? Suppose that the firm is not charging the agent per unit of indemnity. Instead, it can propose to give the agent the total wealth æ1 in the 'good state' and the total wealth xz in the 'bad state' in return for the agents entire wealth W = 60 000 + 20000 = 80 000 and W – L = 80 000 – 60 000 = 20 000, respectively. Below, we shall refer to the pair (21, 12) as a contract. Given the coverage chosen by the individual in Question 2, which of the following statements is correct? O a. There is a contract that is preferable to the outcome…arrow_forwardSuppose Hilary wants to invest in real estate and is considering two different residential properties. Based on the expected incomes and operating expenses of each, she estimates that the first property (property A) has an NOI of $43,000 and that the other (property B) has an NOI of $36,000. If the cap rate is 9%, property A has an estimated value of and property B has an estimated value of . In deciding between these two properties, it is important for Hilary to consider other factors. If she is a first-time investor, she is probably better off investing in property. (Note: Round your answers to two decimal places.) Alternatively, Hilary might want to consider investing in a real estate investment trust (REIT), a type of investment company that operates similarly to mutual fund. Which of the following statements regarding REITs are true? Check all that apply. They pay dividends. Income distributed from REIT investments is taxed at 15%. They…arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Managerial Economics: A Problem Solving ApproachEconomicsISBN:9781337106665Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike ShorPublisher:Cengage Learning
Managerial Economics: A Problem Solving Approach
Economics
ISBN:9781337106665
Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:Cengage Learning