Scenario 5.8:
Risk-neutral Icarus Airlines must commit now to leasing 1, 2, or 3 new airplanes. It knows with certainty that on the basis of business travel alone, it will need at least 1 airplane. The marketing division says that there is a 50% chance that tourism will be big enough for a second plane only. Otherwise, tourism will be big enough for a third plane. This, plus revenue information, yields the following table:
Planes Tourism Revenue Expected
Leased Light Heavy Profit
2 $90 million $30 million $60 million
3 $10 million $140 million $75 million
-Refer to Scenario 5.8. The value to Icarus Airlines of complete information is
A) $40 million.
B) $90 million.
C) $115 million.
D) $120 million.
E) $125 million.

Question

Quizplus · Accepted Answer

The expected profit without complete information is $75 million (from leasing 3 planes). With complete information, Icarus Airlines would lease 2 planes if tourism is light (earning $90 million) and 3 planes if tourism is heavy (earning $140 million). The expected profit with complete information is 0.5 * $90 million + 0.5 * $140 million = $115 million. The value of complete information is $115 million - $75 million = $40 million.

Scenario 5.8: Risk-Neutral Icarus Airlines Must Commit Now to Leasing 1, 2