Key20032s - BUSINESS 702 MANAGERIAL ECONOMICS SECOND EXAM...

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BUSINESS 702 SECOND EXAM KEY SPRING 2003 MANAGERIAL ECONOMICS PLEDGE: "On my honor, I have neither given nor received any unauthorized aid on this exam, nor am I aware of anyone giving or receiving any unauthorized aid on this exam." ________________________________________ Signature ________________________________________ Name (Print) SHORT ANSWER QUESTIONS (30 pts, 15pts each) 1. (P14.2Certainty Equivalents.) The certainty equivalent concept can be widely employed in the analysis of personal and business decision making. Indicate whether each of the following statements is true or false and explain why: A. The appropriate certainty equivalent adjustment factor, a, indicates the minimum price in certain dollars that an individual should be willing to pay per risky dollar of expected return. B. An a 1 implies that a certain sum and a risky expected return of different dollar amounts provide equivalent utility to a given decision maker. C. If previously accepted projects with similar risk have as in a range from a = 0.4 to a = 0.5, an investment with an expected return of $150,000 is acceptable at a cost of $50,000. D. A project for which NPV > 0 using an appropriate risk-adjusted discount rate has an implied a factor that is too large to allow project acceptance. E. State lotteries that pay out 50% of the revenues that they generate require players who place at least a certain $2 value on each $1 of expected risky return. P14.2 SOLUTION
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2 A. False. The certainty equivalent adjustment factor a indicates the maximum price in certain dollars that an individual is willing to pay per risky dollar of expected return. B. True. The a factor is the ratio of a certain sum divided by an expected risky amount that are equivalent in terms of utility, but may differ in strict dollar terms, as in the case of a 1. C. If similar projects implicitly involve a’s in a range from a = 0.4 to a = 0.5, then the maximum certain sum equivalent of an expected risky $150,000 falls in the range between $60,000 (= 0.4 × $150,000) and $75,000 (= 0.5 × $150,000), because: a = Certain sum Expected risky amount = a × Expected risky amount Therefore, a project cost of $50,000 would not only be acceptable, but represents a bargain! D. A project which has NPV > 0 using the risk adjusted discount rate approach has an a factor below the maximum acceptable level. Such a project will be desirable, because it has a “price per risky dollar of return” below that necessary to induce investment. E. State lotteries that pay back 50% of the amount bet involve players who have an a $ 2. 2. (P7.2 Production Function Concepts .) Indicate whether each of the following statements is true or false. Explain your answers.
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Key20032s - BUSINESS 702 MANAGERIAL ECONOMICS SECOND EXAM...

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