Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his unive
ID: 2612507 • Letter: K
Question
Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:
Equipment
Favorable Market ($)
with probability 70%
Unfavorable Market ($)
with probability 30%
Sub 100
300,000
–200,000
Oiler J
250,000
–100,000
Texan
75,000
–18,000
For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.
Although Ken Brown is the principal owner of Brown Oil, his brother Bob is credited with making the company a financial success. Bob is vice president of finance. Bob attributes his success to his pessimistic attitude about business and the oil industry.
1. If Ken believes that Sub 100 cannot get $300,000 even in a favorable market, then this figure needs to be at least less for Ken to change his decision. (Please round to a whole dollar.)
Equipment
Favorable Market ($)
with probability 70%
Unfavorable Market ($)
with probability 30%
Sub 100
300,000
–200,000
Oiler J
250,000
–100,000
Texan
75,000
–18,000
Explanation / Answer
Expected profit if Ken buys Sub 100 = 70% * $300,000 + 30% * (-$200,000)
= $150,000
Expected profit if Ken buys Oliver J = 70% * $250,000 + 30% * (-$100,000)
= $145,000
Expected profit if Ken buys Texan = 70% * $75,000 + 30% * (-$18,000)
= $47,100
Given the expected profit, Sub 100 seems the best option for investment.
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