• Author / Uploaded
• Nicolas Ajiquichi

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This is a decision-making-under-uncertainty case. There are two events: a favorable market (event 1) and an unfavorable market (event 2). There are four alternatives, which include do nothing (alternative 1), invest in corporate bonds (alternative 2), invest in preferred stock (alternative 3), and invest in common stock (alternative 4). The decision table is presented below. Note that for alternative 2, the return in a good market is $30,000  1  0.13 5  $55,273 . The return in a good market is $120,000  4  $30,000 for alternative 3, and $240,000  8  $30,000 for alternative 4.

a

f

Alternative 1 (not invest) Alternative 2 (bonds) Alternative 3 (preferred) Alternative 4 (common)

Event 1 0 55,273 120,000 240,000

Event 2 0 –10,000 –15,000 –30,000

Solutions: Equally Likely Alternative Expected Value 1 0.0 2 22,636.5 3 52,500.0 4 105,000.0 best Maximin Alternative Expected Value 1 0 best 2 –10,000 3 –15,000 4 –30,000 Maximax Alternative Maximax Payoff 1 0 2 55,273 3 120,000 4 240,000 best Probability of 0.11 of Success Alternative Payoff 1 0.00 2 –2,819.97 3 –150.00 4 –300.00

best

1.

Sue Pansky is a risk avoider and should use the maximin decision approach. She should do nothing and not make an investment in Starting Right.

2.

Ray Cahn should use a success probability of 0.11. The best decision is to do nothing.

3.

Lila Battle should eliminate alternative 1, doing nothing, and apply the maximin criterion. The result is to do nothing.

4.

George Yates should use the equally likely decision criterion. The best decision for George is to invest in common stock.

5.

Pete Metarko is a risk seeker. He should invest in common stock.

6.

Julia Day can eliminate the preferred stock alternative and still offer alternatives to risk seekers (common stock) and risk avoiders (doing nothing or investing in corporate bonds).