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Question: consider that you are a risk averse manager who has...

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Consider that you are a risk averse manager who has the following prospects of an investment:

 

·        Certain prospect: you get $10,000 (for certain) with a utility of 34 or;

 

·        Uncertain prospect: 

-if the project is successful you get $15,000 (probability of 50%) with a utility of 37;

-if the project is unsuccessful you get $5,000 (probability of 50%) with a utility of 25; and

 

·        Assume that $8,500 is the certainty equivalent and corresponds to a utility of 31

 

a) Provide an illustration of relationship between utility and income with corret labelling.

(4 marks)

 

 

b) What is the EMV of the project? (show workings).                                              (2 marks) 

 

 

 

 

 

 

c) What is the expected utility of the project and how does it compare with the utility of the certain prospect? (show workings).                                                                                    (3 marks)

 

 

 

 

 

 

d) Would you accept the project? (Explain your answer)                                          (3 marks)

 

 

 

 

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