A firm is considering the decision of investing in new plants.It can choose no new plants,one new plant,or two new plants.The following table gives the profits for each choice under three states of the economy.The manager assigns the following probabilities to each state of the economy: the economy expands,20%,the economy contracts,40%,or the economy is unchanged 40%. Using the coefficient of variation rule,the firm should build
A)no new plants.
B)one new plant.
C)two new plants.
D)cannot tell with this information

Question

A firm is considering the decision of investing in new plants.It can choose no new plants,one new plant,or two new plants.The following table gives the profits for each choice under three states of the economy.The manager assigns the following probabilities to each state of the economy: the economy expands,20%,the economy contracts,40%,or the economy is unchanged 40%.  Using the coefficient of variation rule,the firm should build
A)no new plants. 
B)one new plant. 
C)two new plants. 
D)cannot tell with this information

Quizplus · Accepted Answer

To calculate the coefficient of variation for each option, we divide the standard deviation by the expected value (profit) for each option:

Option 0: 
CV = 506 / 0 = undefined

Option 1: 
CV = 222 / 29,400 = 0.0075

Option 2: 
CV = 78 / 39,000 = 0.002

The lower the coefficient of variation, the less risky the option is relative to its expected profit. Option 2 has the lowest coefficient of variation, indicating that it is the least risky option. However, its expected profit is only slightly higher than that of option 1, while requiring twice the investment. Therefore, option 1 is the best choice, as it has a relatively low coefficient of variation and a higher expected profit compared to option 0.

A Firm Is Considering the Decision of Investing in New