A defendant believes there is a 40 percent chance that the plaintiff will win $1,000,000 and a 60 percent chance that the plaintiff will lose and be awarded nothing (zero). The plaintiff believes that there is a 60 percent chance that they will win $1,000,000 and a 40 percent chance that they will be awarded nothing (zero). The plaintiff's litigation cost is $100,000 and the defendant's litigation cost is $400,000. Which of the following statements is true?

Question

Quizplus · Accepted Answer

To determine the settlement value, we calculate the expected value of the lawsuit for each party and subtract their litigation cost. For the defendant, the expected value of the lawsuit is: 
0.4 * $1,000,000 + 0.6 * $0 = $400,000

So the defendant would be willing to pay up to $400,000 to settle since that would be equivalent to going to trial and losing. However, they also want to consider the cost of litigation, so the maximum they would be willing to pay is $800,000 ($400,000 + $400,000).

For the plaintiff, the expected value of the lawsuit is:
0.6 * $1,000,000 + 0.4 * $0 = $600,000

Subtracting the litigation cost of $100,000, the plaintiff would be willing to accept any settlement amount greater than $500,000 ($600,000 - $100,000).

Therefore, the best choice is C because it is the highest amount the defendant would be willing to pay while still being economically rational, and it is lower than the lowest amount the plaintiff would be willing to accept.

A Defendant Believes There Is a 40 Percent Chance That