Suppose you are the economic advisor for a firm that is trying to decide whether

Question

Suppose you are the economic advisor for a firm that is trying to decide whether to acquire the Bumbler Oil Company, whose only asset is an oil field that has a net value X under their current management. The owners of Bumbler know the exact value of X but your company knows only that X is a random number that is uniformly distributed between 0 and 100. Because of your company's superior management, Bumbler's oil field would be worth 2X in its hands. If you acquire Bumbler, you will have to pay P+5, where P is the price you bid for the company, and the 5 goes for brokerage fees.

                  What is the highest value of P you can bid and still not expect to make a loss if your company acquires Bumbler Oil and why?

Explanation / Answer

buying rate = x

selling rate = 2x

other costs = p +5

profit = 2x - x -(p+5) = X -p -5

we expect the profit to be greater than 0.

i.e E(profit) > 0

E (X - p-5) = -p-5+ E(X)

E(X) = (b+a)/2 (for uniform distribution with paramers a,b)

E(X) = 50

-P-5+50 > 0

P < 45

We can bid a maximum value of 45

Related Questions

Navigate

• Browse (All)
• Browse S
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.