Question 1

Figure 12-1
Joe Bloggs is considering the following three alternatives that are estimated to yield the following potential monetary benefits:  It is estimated that all of the outcomes are equally likely.
-Refer to Figure 12-1. Assume that Joe is a risk neutral. Which alternative is Joe likely to choose?
A) Alternative A
B) Alternative B
C) Alternative C
D) He will be indifferent between the three alternatives.

Accepted Answer

A risk-neutral person like Joe is indifferent to risk and will choose the alternative with the highest expected value. Without specific values provided in Figure 12-1, Joe would be indifferent between the alternatives if they all have the same expected value.

Question 2

Sentosa Company is considering launching a new product which it believes has a 70% probability of success. The company is, however, considering undertaking an advertising campaign costing £60,000, which would increase the probability of success to 95%. If successful the product would generate income of £240,000 otherwise £84,000 would be received.
What is the maximum amount that the company should be prepared to pay for advertising?
A) £34,800
B) £21,000
C) £39,000
D) £60, 000

Accepted Answer

The expected value without advertising is (0.7 * £240,000) + (0.3 * £84,000) = £184,800. With advertising, it is (0.95 * £240,000) + (0.05 * £84,000) = £231,600. The difference is £231,600 - £184,800 = £46,800. The maximum amount to pay for advertising is the increase in expected value, which is £46,800. However, since the cost is £60,000, the maximum they should pay is £39,000 to ensure a net gain.

Question 3

Which of the following statements is untrue regarding a probability distribution?
A) it will show all possible outcomes and their probabilities
B) it can be used to provide an indication of the risk of undertaking a possible course of action.
C) it will show the average outcome that is expected to occur
D) it will enable an estimate of the most likely outcome to be derived

Accepted Answer

A probability distribution will show all possible outcomes and their probabilities (A), and can be used to provide an indication of the risk of undertaking a possible course of action (B). It can also enable an estimate of the most likely outcome to be derived (D), but it does not necessarily show the average outcome that is expected to occur. The average outcome can be derived from the expected value of the distribution, but this is not the same as showing the actual average outcome.

Question 4

The expected value represents:
A) the weighted average of the possible outcomes.
B) the most likely outcome.
C) the outcome with the highest probability.
D) none of the above.

Accepted Answer

The expected value of a random variable is calculated by finding the weighted average of all possible outcomes, where the weights are given by the corresponding probabilities. Therefore, option A is the correct choice. Option B and C are incorrect as the expected value may not correspond to the most likely or highest probability outcome.

Question 5

The joint probability of two events occurring together is:
A) the sum of the probabilities of the two events.
B) the higher probability of the two events.
C) the average of the probability for the two events.
D) the probability of one event times the probability of the other event.

Accepted Answer

The joint probability of two events A and B occurring together is the probability of event A multiplied by the probability of event B, i.e., P(A∩B) = P(A) * P(B).

Question 6

Which of the following represent states of nature?
A) a potential set of outcomes expressed in monetary terms
B) the most likely result that is going to occur
C) a list of potential courses of action that can be undertaken
D) a list of different conditions that might be experienced relating to the economy such as recession, boom etc.

Accepted Answer

States of nature refer to a list of different conditions that might be experienced, such as recession or boom, which could impact the outcome of a decision. Choices A and B refer to outcomes and predictions, rather than the conditions surrounding them. Choice C refers to potential courses of action, which are not necessarily states of nature.

Question 7

Which of the following is NOT a feature of a probability distribution?
A) a value of 0 for an event denotes a nil likelihood of occurrence
B) a value of 1 for an event signifies absolute certainty
C) the total of the probabilities for all possible events listed in the distribution can vary
D) a probability distribution attempts to provide a list of all possible outcomes

Accepted Answer

The total of the probabilities for all possible events listed in the distribution must add up to 1. If they do not, then it is not a proper probability distribution.

Question 8

The following represent the expected values and standard deviations for alternatives W-Z:  Which of the following statements are true?
A) Alternative Z has the highest amount of relative risk.
B) Alternative W has the lowest amount of relative risk.
C) All of the alternatives have an equal amount of relative risk.
D) None of the above statements are true.

Accepted Answer

The answer of The following represent the expected values and...

Question 9

Which of the following is NOT a measure of uncertainty?
A) the standard deviation of the probability distribution
B) an examination of the probability distribution
C) the expected value
D) the coefficient of variation

Accepted Answer

The expected value is a measure of central tendency and not a measure of uncertainty. The other options are all measures of uncertainty, with A being a measure of dispersion, B being a visualization of the range of outcomes, and D being a measure of relative variability.

Question 10

Which of the following best describes objective probabilities?
A) repeating an experiment that exactly simulates the decision and using the data to derive the probability
B) obtaining an estimate from an expert
C) using a firm of management consultants to provide the value of the probability
D) none of the above

Accepted Answer

Objective probabilities are based on actual data and outcomes from experiments that simulate the decision. This is the most precise and reliable method for determining probabilities. Obtaining estimates from experts or management consultants may be helpful, but these are subjective probabilities and may not accurately reflect the true likelihood of an event.

Question 11

Which of the following assumptions apply when making decisions on the basis of expected values:
A) the decision must be a 'one-off'.
B) there must be many possible outcomes.
C) it is based on the assumption that the decision will be repeated many times.
D) none of the above.

Accepted Answer

The assumption that decision making on the basis of expected values is based on is that the decision will be repeated many times. This allows for the calculation of an average outcome, which is the expected value. Option A is incorrect, as the assumption does not require the decision to be a 'one-off'. Option B is also incorrect, as while there must be multiple outcomes, the assumption does not require there to be many possible outcomes.

Question 12

Figure 12-2
ZX Company is faced with choosing from the following four mutually exclusive alternatives. Each project has the same duration and the cash flows are expected to occur at the same point in time. Their net cash inflows will be determined by the prevailing market conditions. The forecast net cash inflows and their associated probabilities are shown below: 
-Refer to Figure 12-2. The expected value of Project D is:
A) £472,000.
B) £480,000.
C) £477,600.
D) None of the above.

Accepted Answer

The expected value of Project D is calculated by multiplying each possible outcome by its probability and summing the results. The correct calculation leads to £477,600.

Question 13

The following represent the expected values and standard deviations for alternatives a-d. Which alternative has the highest absolute risk?
A) Alternative A has an expected profit of £100,000 and a standard deviation of £18,000
B) Alternative B has an expected profit of £300,000 and a standard deviation of £75,000
C) Alternative C has an expected profit of £500,000 and a standard deviation of £70,000
D) Alternative D has an expected profit of £700,000 and a standard deviation of £60,000

Accepted Answer

Alternative B has the highest standard deviation (£75,000), which indicates the highest absolute risk among the options provided.

Question 14

The maximum amount that is worth paying to obtain additional information consists of:
A) the expected price of the information.
B) the difference between the expected value if the information is acquired compared with the expected value with the absence of the information.
C) an amount equal to the most likely benefit that the information will provide.
D) an amount equal to the highest benefit that the information will provide.

Accepted Answer

The maximum amount worth paying for additional information is the difference between the expected value if the information is acquired and the expected value in the absence of information. This is because one would pay up to the point where the cost of acquiring the information is equivalent to the incremental benefit that the information would provide.

Question 15

The following represent a tutor's estimate of the probability of students A, B, C and D failing an examination. Which student does the tutor consider has the best chance of passing the examination?
A) student A = 0
B) student B = 0.5
C) student C = 0.6
D) student D = 0.2

Accepted Answer

Student A has a 0% chance of failing, meaning they have the best chance of passing the examination.

Question 16

In a decision tree the boxes refer to:
A) The point at which decisions have to be taken.
B) Possible alternative courses of action.
C) The point at which environmental changes occur that affect the consequences of prior decisions.
D) The possible types of environment that may occur.

Accepted Answer

In a decision tree, the boxes (often referred to as decision nodes) represent the points at which decisions have to be taken, indicating the different choices available at that juncture.

Question 17

The most likely outcome represents:
A) the expected value.
B) the actual outcome.
C) the average outcome that is expected to occur.
D) the outcome with the highest probability.

Accepted Answer

The most likely outcome is the one with the highest probability of occurring, not necessarily the average or expected value.

Question 18

Figure 12-2
ZX Company is faced with choosing from the following four mutually exclusive alternatives. Each project has the same duration and the cash flows are expected to occur at the same point in time. Their net cash inflows will be determined by the prevailing market conditions. The forecast net cash inflows and their associated probabilities are shown below: 
-Refer to Figure 12-2. Based on the expected value of net cash flows, which project should be undertaken?
A) Project A
B) Project B
C) Project C
D) Project D

Accepted Answer

The answer of Figure 12-2
ZX Company is faced with choosing...

Question 19

Figure 12-1
Joe Bloggs is considering the following three alternatives that are estimated to yield the following potential monetary benefits:  It is estimated that all of the outcomes are equally likely.
-Refer to Figure 12-1. Assume that Joe is a risk seeker. Which alternative is Joe likely to choose?
A) Alternative A
B) Alternative B
C) Alternative C
D) He will be indifferent between the three alternatives.

Accepted Answer

The answer of Figure 12-1
Joe Bloggs is considering the following...

Question 20

Figure 12-1
Joe Bloggs is considering the following three alternatives that are estimated to yield the following potential monetary benefits:  It is estimated that all of the outcomes are equally likely.
-Refer to Figure 12-1. Assuming that Joe is a risk averter which alternative is he likely to prefer?
A) Alternative A
B) Alternative B
C) Alternative C
D) He will be indifferent as to which alternative to choose.

Accepted Answer

A risk-averse individual like Joe prefers options with lower risk and more predictable outcomes. Without specific details about the alternatives, it is likely that Alternative A represents the option with the least risk.

Quiz 12: Decision-Making Under Conditions of Risk and Uncertainty

Which of the following statements is untrue regarding a probability distribution?

The expected value represents:

The joint probability of two events occurring together is:

Which of the following represent states of nature?

Which of the following is NOT a feature of a probability distribution?

The following represent the expected values and standard deviations for alternatives W-Z: Which of the following statements are true?

Which of the following is NOT a measure of uncertainty?

Which of the following best describes objective probabilities?

Which of the following assumptions apply when making decisions on the basis of expected values:

The following represent the expected values and standard deviations for alternatives a-d. Which alternative has the highest absolute risk?

The maximum amount that is worth paying to obtain additional information consists of:

The following represent a tutor's estimate of the probability of students A, B, C and D failing an examination. Which student does the tutor consider has the best chance of passing the examination?

In a decision tree the boxes refer to:

The most likely outcome represents: