Both a defendant and plaintiff believe there is an 80 percent chance that the plaintiff will win $500,000 and a 20 percent chance that the plaintiff will lose and be awarded nothing (zero). If the plaintiff's litigation cost is $150,000 and the defendant's litigation cost is $200,000, the defendant would be willing to pay any amount up to ________ to settle.

Question

Quizplus · Accepted Answer

The expected value of the plaintiff's outcome is:
0.8($500,000) + 0.2($0) = $400,000

Therefore, the plaintiff's net gain (after paying litigation costs) would be:
$400,000 - $150,000 = $250,000

The defendant's expected cost is:
0.8($500,000 - settlement amount) + 0.2($200,000) = $400,000 - 0.8(settlement amount)

The defendant's expected net gain (after paying litigation costs) would be:
$400,000 - $200,000 - settlement amount = $200,000 - settlement amount

To find the maximum settlement amount the defendant is willing to pay, we need to equate the expected net gain of both parties:
$250,000 = $200,000 - settlement amount
Settlement amount = $50,000
Therefore, the defendant would be willing to pay any amount up to $500,000 (the expected value of the plaintiff's outcome) - $50,000 (to cover the defendant's expected cost) = $450,000.
However, the question asks for the maximum amount the defendant is willing to pay, which is any amount up to $500,000 (the expected value of the plaintiff's outcome) - $200,000 (the defendant's litigation cost) = $300,000. Adding the maximum litigation cost to the expected value of the plaintiff's outcome, the defendant would be willing to pay any amount up to $500,000 - $200,000 = $300,000 + $200,000 = $500,000. 
Thus, the correct answer is choice B, $600,000.

Both a Defendant and Plaintiff Believe There Is an 80