A family business is considering making an investment in its manufacturing operation.Three decisions are under consideration: (1)a large investment; (2)a medium investment;and (3)a small investment.The business believes that there are three possible future outcomes for its product: (1)increasing demand; (2)stable demand;and (3)decreasing demand.The business believes that the probability for increasing,stable and decreasing product demand are 0.4,0.5,and 0.1,respectively.The following payoff table describes the decision situation.

If the expected value criterion is used then the best decision would be to
A)make the large investment
B)make the medium investment
C)make the small investment
D)choose the stable demand

Question

A family business is considering making an investment in its manufacturing operation.Three decisions are under consideration: (1) a large investment; (2) a medium investment;and (3) a small investment.The business believes that there are three possible future outcomes for its product: (1) increasing demand; (2) stable demand;and (3) decreasing demand.The business believes that the probability for increasing,stable and decreasing product demand are 0.4,0.5,and 0.1,respectively.The following payoff table describes the decision situation.

If the expected value criterion is used then the best decision would be to

If the expected value criterion is used then the best decision would be to
A)make the large investment 
B)make the medium investment 
C)make the small investment 
D)choose the stable demand

Quizplus · Accepted Answer

Using the expected value criterion, we calculate the expected payoff for each investment decision as follows:

For the large investment:
Expected Payoff = (0.4)(600) + (0.5)(300) + (0.1)(-200) = 240 + 150 - 20 = 370

For the medium investment:
Expected Payoff = (0.4)(400) + (0.5)(200) + (0.1)(-100) = 160 + 100 - 10 = 250

For the small investment:
Expected Payoff = (0.4)(200) + (0.5)(100) + (0.1)(50) = 80 + 50 + 5 = 135

Therefore, the decision that yields the highest expected payoff is to make the large investment.

A Family Business Is Considering Making an Investment in Its