Problem: A new product has the following profit projections and associated probabilities:
Profit Probability
$150,000 0.10
$100,000 0.25
$ 50,000 0.20
$0 0.15
-$ 50,000 0.20
-$100,000 0.10
1) Use the expected value approach to decide whether to market the new product.
2) Because of the high dollar values involved, especially the possibility of a $100,000 loss, the marketing vice president has expressed some concern about the use of the expected value approach. As a consequence, if a utility analysis is performed, what is the appropriate lottery?
3) Assume that the following indifference probabilities are assigned. Do the utilities reflect the behaviour of a risk taker or a risk avoider?
Profit Indifference Probability (p)
$100,000 0.95
$ 50,000 0.70
$0 0.50
-$ 50,000 0.25
4) Use expected utility to make a recommended decision.
5) Should the decision maker feel comfortable with the final decision recommended by the analysis?