An individual is considering two investment projects. Project A will return a ze
ID: 1179813 • Letter: A
Question
An individual is considering two investment projects. Project A will return a zero profit if condition are poor, a profit of $4 if conditions are good, and a profit of $8 if conditions are excellent. Project B will return of $2 if conditions are poor, aprofit of $3 if conditions are good, and a profit of $4 if conditions are excellent. The probability distribution of conditions is as follows:
Condtions: Poor Good Excellent
Probability: 40% 50% 10%
(a) Using Excel calculate the expected value of each project and identify the preferred project according to this criterion. (b) Assume that the indivdual
Explanation / Answer
a) expected value of project A =40%*0 + 50%*4+ 10%*8 =$2.8
expected value of project B =40%*2 + 50%*3+ 10%*4 =$2.7
preferred project according to this criterion is Project A because it has higher expected value
b)U(X) for A =2.8-0.05*2.8^2 = 2.41
U(X) for B =2.7-0.05*2.7^2 = 2.34
preferred project according to this criterion is Project A because it has higher expected utility
c. This person is risk seeking as he has higher utility for the project which has higher expected value