A manager believes there is a 10 percent chance their firm will have to pay $500,000, a 20 percent chance that they will have to pay $400,000 and a 70 percent chance they will be found innocent and pay nothing except the legal fees of $100,000. The manager has been offered a settlement deal of $230,000, which the manager's firm would have to pay the plaintiff. If the manager flips a coin to decide to enter litigation or to settle, the manager is_______ .

Question

Quizplus · Accepted Answer

The manager is risk neutral because they are indifferent between a certain outcome (the settlement) and a gamble (litigation) with the same expected value. The expected cost of litigation is calculated as (0.1 * $500,000) + (0.2 * $400,000) + (0.7 * $100,000) = $180,000. Since the settlement of $230,000 is higher than the expected cost of litigation, choosing between the settlement and litigation based on a coin flip indicates neutrality towards risk.

A Manager Believes There Is a 10 Percent Chance Their