$1M is available to invest in S or B. The percentage yield on each investment depends...

60.1K

Verified Solution

Question

Basic Math

$1M is available to invest in S or B. The percentage yield oneach investment depends on whether the econ has a good or badyear.
Econ has a Good year    Econ has a Bad year
Yield on S    22% of 1M 10% of 1M
   (i.e. $220,000)    ($100,000)
Yield on B 16% of 1M 14% of 1M
($160,000) ($140,000)
It is equally likely (50%) that the econ will have a good or badyear.
For $10,000, a firm can be hired to forecast the state of theecon. The firm's forecasts have the following probabilities:
p(Good forecast | Econ is good) = .8
p(GF | EIB) = .2
It is equally likely (50%) for EIG & EIB to occur
a) Calculate the following:
p(EIG | GF) =
p(EIB | GF) =
p(EIG | BF) =
p( EIB | BF) =
b) Draw a decision tree to determine to invest in S or B tomaximize expected profits. Should the firm be hired?
c) What are the values of the EVSI and EVPI?

Answer & Explanation Solved by verified expert

4.1 Ratings (458 Votes)

a We know the following probabilitiesLet EIG be the event that the economy is good and EIB be theevent that the economy is badPEIG 050PEIB050Let GF be the event that the firm forecasts that the economy isgood and BF be the event that the firm forecasts that the economyis badWe know the following conditional probabilitiesThe marginal probability of getting a good forecast isThe marginal probability of getting a bad forecast isPBF 1 PGF 1050050Now we get the probabilities that we needb Now the decision treeMoving from the right to the left we haveChance node 6 Hire the firm ignore the cost to hire for nowand invest in S if good forecastThe expected value isChance node 7 Hire the firm See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member