David trying to determine which of two investments is better for his retirement.

Question

David trying to determine which of two investments is better for his retirement. If he invests in company he believes he has.10% chance of receiving $2000 per month, 40% chance of receiving $1500 per month, and 50% change of receiving $1000, If he invests on company Y, he has a 70% change of receiving $1500, 25% chance for $1000, and a 5% change for $500, David is indifference between the following lotteries: If David wants to invest in the company that maximizes the expected utility of his investment, which company should he take? x rightarow y rightarrow

Explanation / Answer

Answer to the question)

The expected value of X is :

E(x) = 0.10*2000+0.40*1500+0.50*1000

E(x) = 200 + 600 + 500

E(x) = 1300

.

The expected value of Y is:

E(y) = 0.70*1500 + 0.25*1000 + 0.05*500

E(y) = 1050 + 250 + 25

E(y) = 1325

.

Thus we find that the expected value of Y (1325) is higher than the expected value of X (1300)

Thus David must invest in Y

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