Jo Thomkins must decide whether or not to proceed with a particular investment p

Question

Jo Thomkins must decide whether or not to proceed with a particular investment project. If the project succeeds, Jo will gain $15 million. If the project fails, she will lose $3 million. Jo estimates that there is a 20% chance that the project will succeed and an 80% chance that it will fail. A consultant could tell Jo with certainty if the project will succeed or fail, but only for a fee.

What is the most that Jo should be willing to pay the consultant for the information? Explain. Assume that Jo has correctly estimated the probabilities of the project’s likely success and failure.

Explanation / Answer

Solution:

Option 1) If Jo Thomkins does not hire the consultant, the expected value equals $0.6 million (=15X0.2 + (-3)X0.8 )

Option 2) If Jo Thomkins hire the consultant, the expected value $3 million (=15*0.2 + (0)*0.8)

Thus the consultant will increase the expected value by mount of $2.4 million. Hence$2.4 million would be the amount that would be willing to pay the consultant.

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