QUESTION 4 [Include all of your answers in a SINGLE document and attach that doc

Question

QUESTION 4 [Include all of your answers in a SINGLE document and attach that document at the end of the exam. Label each answer clearly. Please begin each problem on a new page/sheet. Point values are indicated in the question body below.] Problem 4: A young couple has some money to invest in either savings bonds or a real estate deal. The expected payoff for each investment, given good and bad economic conditions, is shown in the following table: Economic Conditions Good 0.6 S 2,000 Investment Savings bonds Real estate 0.4 S 2,000 -2,000 8,000 a). The probability of good economic conditions is 0.6, and the probability of bad economic conditions is 0.4. Compute the EMV for each investment. Which investment should the couple choose? Why? [6 pts] b). What is the expected value of perfect information (EVPI) for the couple's decision? [6 pts] c). Examine the probability of good economic conditions. For what value of this probability would the couple be indifferent between the two investments? [6 pts]

Explanation / Answer

a) EMV for savings = 0.6*2000+0.4*2000=2000

a) EMV for real estate=0.6*8000-0.4*2000=3200

b) EVPI = 0.6*8000+0.4*2000 - 3200=4800+800-3200=2400

c) x*8000-(1-x)*2000=2000

x=0.4

Indifferent if P(good)=0.4

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