n investment counselor calls with a hot stock tip. He believes that if the econo

Question

n investment counselor calls with a hot stock tip. He believes that if the economy remains strong, the investment will result in a profit of $60 , 000. If the economy grows at a moderate pace, the investment will result in a profit of $20 , 000. However, if the economy goes into recession, the investment will result in a loss of $60 , 000. You contact an economist who believes there is a 20% probability the economy will remain strong, a 60% probability the economy will grow at a moderate pace, and a 20% probability the economy will slip into recession. What is the expected profit from this investment?

Explanation / Answer

Here Probability of economy wil remain strong ; Pr(strong) = 0.20 ; Profit in strong economy = $ 60,000

Pr(moderate economy) = 0.60 ; profit in moderate economy = $ 20000

Pr(Recession) = 0.20 ; Profit in recression = - $ 60000

Expected profit from the investment = 0.20 * 60000 + 0.60 * 20000 + 0.20 * (-60000) = $ 12,000

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