A defendant believes there is a 70 percent chance that the plaintiff will win $800,000 and a 30 percent chance that the plaintiff will lose and be awarded nothing (zero). The plaintiff believes that there is a 90 percent chance that they will win $800,000 and a 10 percent chance that they will be awarded nothing (zero). The plaintiff's litigation cost is $300,000 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

To find the expected value of an outcome in probability, we add the product of the probability and the payout for each possible outcome.

For the defendant, the expected value of going to trial is:

0.7($800,000) - 0.3($0) - $200,000 = $460,000

For the plaintiff, the expected value of going to trial is:

0.9($800,000) - 0.1($0) - $300,000 = $510,000

If the defendant is willing to pay up to settle, we want to find the amount that will make the expected value of going to trial equal to the settlement amount.

0.7($800,000) - 0.3($0) - $200,000 = settlement amount

Solving for the settlement amount, we get:

Settlement amount = $760,000

Therefore, the best choice is C) $760,000.

A Defendant Believes There Is a 70 Percent Chance That