!\"3 ) 4 is considering expansion of a store. If he expands, the interest rate a

Question

!"3 ) 4 is considering expansion of a store. If he expands, the interest rate at which he borrows oy is the important factor. He is not sure what kind of interest rate will be obtained. If he ummarizes the situation: Probabilitics Payoft Expand Very favorable Favorable Neutral Unfavorable Very unfavorable 580,000 2 $60,000 · $20,000 3 $20,000 2 $30,000 Economy up Economy same Economy down 2 $50,000 $30,000 $10,000 .3 Draw the decision tree showing all nodes and expected values. What should he do?

Explanation / Answer

Victor should not expand his store as expected payoff is more for “Do not expand”

Decision Tree Situation Probabilities Payoff Expected Payoff =(Probability * payoff) Total Expected value at each node (sum of each Expected payoff) Very favorable 0.2 $80,000 $16,000 Favorable 0.2 $60,000 $12,000 Expand Neutral 0.1 $20,000 $2,000 $18,000 Unfavorable 0.3 -$20,000 -$6,000 Very Unfavorable 0.2 -$30,000 -$6,000 Store Economy Up 0.2 $50,000 $10,000 Do not Expand Economy Same 0.5 $30,000 $15,000 $28,000 Economy down 0.3 $10,000 $3,000

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