In this chapter a decision tree was developed for John Thompson. After completin

Question

In this chapter a decision tree was developed for John Thompson. After completing the analysis, John was not completely sure that he is indifferent to risk. After going through a number of standard gambles, John was able to assess his utility for money. Here are some of the utility assessments: U( - $190,000) = 0, U( - $180,000) = 0.05, U(- $30,000) = 0.10, U((-$20,000) = 0.15, U(-$10,000) = 02, U($0) = 0.3, U($90,000) = 0.5, and U($100,000) = 0.6, U($190,000) = 0.95 and U($200,000) = 1.0 If John maximizes his expected utility, does his decision change? In this chapter a decision tree was developed for John Thompson. After completing the analysis, John was not completely sure that he is indifferent to risk. After going through a number of standard gambles, John was able to assess his utility for money. Here are some of the utility assessments: U( - $190,000) = 0, U( - $180,000) = 0.05, U(- $30,000) = 0.10, U((-$20,000) = 0.15, U(-$10,000) = 02, U($0) = 0.3, U($90,000) = 0.5, and U($100,000) = 0.6, U($190,000) = 0.95 and U($200,000) = 1.0 If John maximizes his expected utility, does his decision change?

Explanation / Answer

EU(large plant | survey favorable) = 0.78(0.95) + 0.22(0) = 0.741

EU(small plant | survey favorable) = 0.78(0.5) + 0.22(0.1) = 0.412

EU(no plant | survey favorable) = 0.2

EU(large plant | survey negative) = 0.27(0.95) + 0.73(0) = 0.2565

EU(small plant | survey negative) = 0.27(0.5) + 0.73(0.10) = 0.208

EU(no plant | survey negative) = 0.2

EU(large plant | no survey) = 0.5(1) + 0.5(0.05) = 0.525

EU(small plant | no survey) = 0.5(0.6) + 0.5(0.15) = 0.375

EU(no plant | no survey) = 0.3

EU(conduct survey) = 0.45(0.741) + 0.55(0.2565) = 0.4745

EU(no survey) = 0.525

John’s decision would change. He would not conduct the survey and build the large plant.

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