Q2. John Thomas of Thomas Manufacturing Company knows that the economy could con
ID: 3361843 • Letter: Q
Question
Q2. John Thomas of Thomas Manufacturing Company knows that the economy could continue at a high level (boom), continue at a reduced level or go into a recession. His options are to invest $100,000 in either expanding his business, in the stock market or in a certificate of deposit. Of course, the unknown is whether the economy will continue at a high level, a reduced level or go into a recession. No matter what happens, the certificate of deposit will result in a gain of 6 percent. If the economy booms, an expansion of production will result in a 15 percent gain, and stock investment will produce a 12 percent gain. If the economy goes to a reduced level, an expansion of production will result in a 2% gain and a stock investment will result in a 4% gain. If there is a recession, he predicts a 10 percent loss if he expands his production and a 5 percent loss if he invests in stocks. a. Set up the Payoff table. b. If the probability of a recession or a boom is 20% each, what should Thomas do? (Hint: Setup the Expected Monetary Value table: find best option in this circumstance.) Be sure to head your document with your name and the date of submission , PrtScn FS F6 Home End F7Explanation / Answer
a.
The Payoff table is,
b. Probability of boom = Probability of recession = 0.2
Probability of reduced level = 1 - (0.2 + 0.2) = 0.6
As, the EMV (expected monetary value) for Certificates of Deposits is greater than other two, the best option is to invest in Certificates of Deposits.
Alternatives Economy Boom Reduced level Recession Expand Business $100,000*15% = $15,000 $100,000*2% = $2000 $100,000*(-10%) = -$10,000 Stock Markets $100,000*12% = $12,000 $100,000*4% = $4000 $100,000*(-5%) = -$5,000 Certificates of Deposits $100,000*6% = $6,000 $100,000*6% =$6,000 $100,000*6% = $6,000Related Questions
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