Scenario 5.9:
Torrid Texts, a risk-neutral new firm that specializes in making college textbooks more interesting by inserting contemporary material wherever possible, is planning for next year's production and must decide how many paper producers to contract with. It knows fairly well what the general demand for textbooks is, but is uncertain how faculty will react to this new material. If faculty react very negatively, the firm expects course orders to be down. The executives at Torrid believe that the likelihood of a positive faculty response is 75%. The table below contains profit information under the different possible outcomes.
Producers Faculty Reaction Expected
Contracted Negative Positive Profit
1 $3 million $30 million $23.25 million
2 $1 million $60 million $45.25 million
-Refer to Scenario 5.9. Given that the probability of a positive faculty response is 75%, Torrid Texts' expected profit under complete information would be
A) $23.25 million.
B) $45 million.
C) $45.25 million.
D) $45.75 million.
E) $60 million.

Question

Quizplus · Accepted Answer

The expected profit under complete information is calculated by taking the weighted average of profits based on the probability of each outcome. With a 75% chance of a positive response and a 25% chance of a negative response, the expected profit is (0.75 * $60 million) + (0.25 * $1 million) = $45.75 million.

Scenario 5.9: Torrid Texts, a Risk-Neutral New Firm That Specializes in Making