An individual is considering two investment projects. Project A will return a ze

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

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