The Disney Corporation is thinking about taking its hit Broadway musical, The Li

Question

The Disney Corporation is thinking about taking its hit Broadway musical, The Lion King on tour. It has made the following calculations: The tour would cost $12 million; there is a .30 chance that it will earn $32 million (high earnings) and a .7 chance it will earn $10 million (low earnings). A Broadway critic says she can preview the play and accurately predict whether the play will have high or low earnings. Ignoring her accuracy for the moment, what’s an absolute top limit to what Disney should be willing to pay for her review?

Explanation / Answer

Let’s calculate expected value = probability of high earnings *( high earnings) + probability of low earnings *( low earnings )

= .3(32)+ .7(10)= 9.6 +7 =$16.6 million

Tour Cost is $12 million ,so profit is $(16.6-12)=$4.6 million. So, Disney can pay maximum of $4.6 million , at which it will have 0 profit, beyond this it will be a loss.

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