# 3 16 a risk seeker is a decision maker who enjoys and

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3-16. A risk seeker is a decision maker who enjoys and seeks out risk. A risk avoider is a decision maker who avoids risk even if the potential economic payoff is higher. The utility curve for a risk seeker increases at an increasing rate. The utility curve for a risk avoider increases at a decreasing rate. 3-17. a. Decision making under uncertainty. b. Maximax criterion. c. Sub 100 because the maximum payoff for this is \$300,000.
3-8 Row Row Equipment Favorable Unfavorable Maximum Minimum Sub 100 300,000 200,000 300,000 200,000 Oiler J 250,000 100,000 250,000 100,000 Texan 75,000 18,000 75,000 18,000 3-18. Using the maximin criterion, the best alternative is the Texan (see table above) because the worst payoff for this (\$ 18,000) is better than the worst payoffs for the other decisions. 3-19. a. Decision making under risk maximize expected monetary value. b. EMV (Sub 100) = 0.7(300,000) + 0.3( 200,000) = 150,000 EMV (Oiler J) = 0.7(250,000) + 0.3( 100,000) = 145,000 EMV (Texan) = 0.7(75,000) + 0.3( 18,000) = 47,100 Optimal decision: Sub 100. c. Ken would change decision if EMV(Sub 100) is less than the next best EMV, which is \$145,000. Let X = payoff for Sub 100 in favorable market. (0.7)(X) + (0.3)( 200,000) 145,000 0.7X 145,000 + 60,000 = 205,000 X (205,000)/0.7 = 292,857.14 The decision would change if this payoff were less than 292,857.14, so it would have to decrease by about \$7,143. 3-20. a. The expected value (EV) is computed for each alternative. EV(stock market) = 0.5(80,000) + 0.5( 20,000) = 30,000 EV(Bonds) = 0.5(30,000) + 0.5(20,000) = 25,000 EV(CDs) = 0.5(23,000) + 0.5(23,000) = 23,000 Therefore, he should invest in the stock market.
3-9 b. EVPI = EV(with perfect information) (Maximum EV without P, I) = [0.5(80,000) + 0.5(23,000)] 30,000 = 51,500 30,000 = 21,500 Thus, the most that should be paid is \$21,500. 3-21. The opportunity loss table is Alternative Good Economy Poor Economy Stock Market 0 43,000 Bonds 50,000 3,000 CDs 57,000 0 EOL(Stock Market) = 0.5(0) + 0.5(43,000) = 21,500* This minimizes EOL. EOL(Bonds) = 0.5(50,000) + 0.5(3,000) = 26,500 EOL(CDs) = 0.5(57,000) + 0.5(0) = 28,500 3-22. a. Market Alternative Condition Good Fair Poor EMV Stock market 1,400 800 0 880 Bank deposit (CD) 900 900 900 900 Probabilities of market conditions 0.4 0.4 0.2 b. Best decision: deposit \$10,000 in bank CD. 3-23. a. Expected value with perfect information is 1,400(0.4) + 900(0.4) + 900(0.2) = 1,100; the maximum EMV without the information is 900. Therefore, Allen should pay at most EVPI = 1,100 900 = \$200. b. Yes, Allen should pay [1,100(0.4) + 900(0.4) + 900(0.2)] 900 = \$80.
3-10 3-24. a. Opportunity loss table Strong Fair Poor Max. Market Market Market Regret Large 0 19,000 310,000 310,000 Medium 250,000 0 100,000 250,000 Small 350,000 29,000 32,000 350,000 None 550,000 129,000 0 550,000 b. Minimax regret decision is to build medium. 3-25. a. Stock Demand (Cases) (Cases) 11 12 13 EMV 11 385 385 385 385 12 329 420 420 379.05 13 273 364 455 341.25 Probabilities 0.45 0.35 0.20 b. Stock 11 cases. c. If no loss is involved in excess stock, the recommended course of action is to stock 13 cases and to replenish stock to this level each week. This follows from the following decision table. Stock Demand (Cases) (Cases) 11 12 13 EMV 11 385 385 385 385 12 385 420 420 404.25 13 385 420 455 411.25
3-11 3-26. Manufacture (Cases) Demand (Cases) 6 7 8 9 EMV 6 300 300 300 300 300 7 255 350 350 350 340.5 8 210 305 400 400 352.5 9 165 260 355 450 317 Probabilities 0.1 0.3 0.5 0.1 John should manufacture 8 cases of cheese spread. 3-27. Cost of produced case = \$5.