Chapter 15: DECISIONS UNDER RISK AND UNCERTAINTY

Multiple Choice

15-1 A probability distribution

a. is a way of dealing with uncertainty.

b. lists all possible outcomes and the corresponding probabilities of occurrence.

c. shows only the most likely outcome in an uncertain situation.

d. both a and b

e. both a and c

Difficulty: 01 Easy

Topic: Measuring Risks with Probability Distributions

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-02

15-2 The variance of a probability distribution is used to measure risk because a higher variance is associated with

a. a wider spread of values around the mean.

b. a more compact distribution.

c. a lower expected value.

d. both a and b

e. all of the above

Difficulty: 01 Easy

Topic: Measuring Risk with Probability Distributions

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-02

15-3 Risk exists when

a. all possible outcomes are known but probabilities can't be assigned to the outcomes.

b. all possible outcomes are known and probabilities can be assigned to each.

c. all possible outcomes are known but only objective probabilities can be assigned to each.

d. future events can influence the payoffs but the decision maker has some control over their probabilities.

e. c and d

Difficulty: 01 Easy

Topic: Distinctions Between Risk and Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-01

15-4 When a manager can list all outcomes and assign probabilities to each

a. uncertainty exists.

b. both risk and uncertainty exist.

c. risk exists.

d. the manager should use the minimax rule for making a decision.

e. b and d

Difficulty: 01 Easy

Topic: Distinctions Between Risk and Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-01

15-5 Subjective probabilities are

a. determined from actual data on part experiences.

b. used in the presence of uncertainty.

c. almost never used from decision making.

d. based on feelings or hunches.

e. c and d

Difficulty: 01 Easy

Topic: Distinctions Between Risk and Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-01

15-6 Choosing the decision with the maximum possible payoff

a. is the maximax rule.

b. ignores possible bad outcomes.

c. is a guide for decision making under uncertainty.

d. all of the above

e. none of the above

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-7 The maximin rule

a. ignores bad outcomes.

b. is used by optimistic managers.

c. minimizes the potential regret.

d. a and c

e. none of the above

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-8 Using the minimax regret rule the manager makes the decision

a. with the smallest worst−potential regret.

b. with the largest worst−potential regret.

c. knowing he will not regret it.

d. that has the highest expected value relative to the other decisions.

Difficulty: 01 Easy

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-05

15-9 In making decisions under risk

a. maximizing expected value is always the best rule.

b. mean-variance analysis is always the best rule.

c. the coefficient of variation rule is always best.

d. maximizing expected value is best for making repeated decisions with identical probabilities.

e. none of the above

Difficulty: 01 Easy

Topic: Decisions Under Risk

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-03

15-10 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, the expected value of project A (in $1,000s) is

a. $60

b. $65

c. $70

d. $75

e. $80

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-11 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, the variance of project A is

a. 7.07

b. 50

c. 440

d. 4,000

e. 380

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-12 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, what is the expected value of project B (in $1,000s)?

a. $60

b. $65

c. $70

d. $75

1. $80

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-13 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, what is the variance of project B?

a. 10

b. 21

c. 165

d. 440

e. 515

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

• 1. A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, a decision maker using the coefficient of variation rule would

a. choose project A.

b. choose project A only if risk averse.

c. choose project B.

d. choose project B only if risk loving.

e. not be able to make a decision using that rule.

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-15 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, a decision maker who is risk neutral would

a. choose project A.

b. choose project B.

c. not be able to make a decision.

d. change probabilities because no decision maker is ever risk neutral.

Difficulty: 02 Medium

Topic: Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-16 A firm is considering two projects, A and B, with the following probability distributions for profit.

Given the above, the coefficient of variation (to 2 decimal places) is

a. higher for A.

b. higher for B.

c. equal for the two.

d. unable to be used for this choice.

e. both c and d

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-17 In the maximin strategy, a manager choosing between two options will choose the option that:

a. has the highest expected profit

b. provides the best of the worst possible outcomes

c. minimizes the maximum loss

d. both a and b

e. both b and c

Difficulty: 01 Easy

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-05

15-18 In the maximax strategy a manager choosing between two options will choose the option that

a. has the highest expected profit.

b. provides the best of the worst possible outcomes.

c. provides the best of the highest possible outcomes.

d. has the lowest variance.

e. a and d

Difficulty: 01 Easy

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Remember

Learning Objective: 15-05

15-19 Refer to the following probability distribution for profit to answer the question below:

What is the expected profit for this distribution?

a. $11,875

b. $46

c. $47.50

d. $48.75

1. none of the above

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-20 Refer to the following probability distribution for profit to answer the question below:

What is the variance of this distribution?

a. 48.75

b. 2,376

c. 525

d. 70

e. 11.875

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-21 Refer to the following probability distribution for profit to answer the question below:

What is the coefficient of variation for this distribution?

a. 1.67

b. 0.675

c. 18.6

d. 0.147

e. 1.03

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-22 The following payoff matrix shows the various profit outcomes for 3 projects, A, B, and C, under 2 possible states of nature: the product price is $10 or the product price is $20.

Using the maximax rule, the decision maker would choose

a. A.

b. B.

c. C.

d. impossible to say from the information given

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-05

15-23 The following payoff matrix shows the various profit outcomes for 3 projects, A, B, and C, under 2 possible states of nature: the product price is $10 or the product price is $20.

Using the maximin rule, the decision maker would choose

a. A.

b. B.

c. C.

d. either A or B because neither has negative profit

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-24 The following payoff matrix shows the various profit outcomes for 3 projects, A, B, and C, under 2 possible states of nature: the product price is $10 or the product price is $20.

Using the maximum expected value rule, the decision maker would choose

a. A.

b. B.

c. C.

d. impossible to tell from the information

Difficulty: 01 Easy

Topic: Measuring Risk with Probability Distributions

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-02

15-25 The following payoff matrix shows the various profit outcomes for 3 projects, A, B, and C, under 2 possible states of nature: the product price is $10 or the product price is $20.

Using the equal probability rule the decision maker would choose

a. A.

b. B.

c. C.

d. impossible to tell from information

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-26 The following payoff matrix shows the various profit outcomes for 3 projects, A, B, and C, under 2 possible states of nature: the product price is $10 or the product price is $20.

Using the minimax regret rule the decision maker would choose

a. A.

b. B.

c. C.

d. impossible to tell from the information

Difficulty: 01 Easy

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-27 The following payoff matrix shows the profit outcomes for three projects, A, B, and C, for each of two possible product prices. There is a 60% probability the price will be $10 and a 40% probability the price will be $20.

Using the maximum expected value rule a decision maker would choose

a. A.

b. B.

c. C.

d. impossible to tell from the information

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-28 The following payoff matrix shows the profit outcomes for three projects, A, B, and C, for each of two possible product prices. There is a 60% probability the price will be $10 and a 40% probability the price will be $20.

Using mean-variance analysis a decision maker would choose

a. A.

b. B.

c. C.

d. can't use this rule under these circumstances

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-29 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

What is the expected profit if 6,000 units are produced?

a. $171

b. $840

c. $640

d. $340

e. $260

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-30 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

What is the expected profit if 10,000 units are produced?

a. $500

b. $700

c. $625

d. $1,000

e. $1,754

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-31 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

If the mean-variance rule is used, how much should the firm produce?

a. 6,000

b. 8,000

c. 10,000

d. cannot use this rule to make the decision

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-32 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

What is the variance if 6,000 units are produced?

a. 490,000

b. 176,400

c. 100,000

d. 68,200

e. 76,460

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-33 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

For the above payoff matrix, suppose the manager has no idea about the probability of any of the three prices occurring. If the maximax rule is used how much will the firm produce?

a. 6,000

b. 8,000

c. 10,000

d. cannot use this rule to make the decision

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-34 A firm making production plans believes there is a 30% probability the price will be $10, a 50% probability the price will be $15, and a 20% probability the price will be $20. The manager must decide whether to produce 6,000 units of output (A), 8,000 units (B) or 10,000 units (C). The following table shows 9 possible outcomes depending on the output chosen and the actual price.

For the above payoff matrix, suppose the manager has no idea about the probability of any of the three prices occurring. If the maximin rule is used how much will the firm produce?

a. 6,000

b. 8,000

c. 10,000

d. cannot use this rule to make the decision

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-35 A firm is considering the decision of investing in new plants. The following is the profit payoff matrix under three conditions: it does not expand, it builds two new plants, or it builds one new plant. Three possible states of nature can exist--no change in the economy, the economy contracts and the economy grows. The firm has no idea of the probability of each state.

What decision would be made using the maximax rule?

a. no new plants

b. one new plant

c. two new plants

d. not enough information to tell

Difficulty: 01 Easy

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-36 A firm is considering the decision of investing in new plants. The following is the profit payoff matrix under three conditions: it does not expand, it builds two new plants, or it builds one new plant. Three possible states of nature can exist--no change in the economy, the economy contracts and the economy grows. The firm has no idea of the probability of each state.

What decision would be made using the maximin rule?

a. no new plants

b. one new plant

c. two new plants

d. not enough information to tell

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-37 A firm is considering the decision of investing in new plants. The following is the profit payoff matrix under three conditions: it does not expand, it builds two new plants, or it builds one new plant. Three possible states of nature can exist--no change in the economy, the economy contracts and the economy grows. The firm has no idea of the probability of each state.

What decision would be made using the maximum expected value rule?

a. no new plants

b. one new plant

c. two new plants

d. not enough information to tell

Difficulty: 01 Easy

Topic: Measuring Risk with Probability Distributions

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-02

15-38 A firm is considering the decision of investing in new plants. The following is the profit payoff matrix under three conditions: it does not expand, it builds two new plants, or it builds one new plant. Three possible states of nature can exist--no change in the economy, the economy contracts and the economy grows. The firm has no idea of the probability of each state.

What decision would be made using the minimax regret rule?

a. no new plants

b. one new plant

c. two new plants

d. not enough information to tell

Difficulty: 02 Medium

Topic: Decisions Under Uncertainty

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-05

15-39 A firm is considering the decision of investing in new plants. The following is the profit payoff matrix under three conditions: it does not expand, it builds two new plants, or it builds one new plant. Three possible states of nature can exist--no change in the economy, the economy contracts and the economy grows. The firm has no idea of the probability of each state.

What decision would be made using the equal probability rule?

a. no new plants

b. one new plant

c. two new plants

d. not enough information to tell

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-40 A firm is considering the decision of investing in new plants. It can choose no new plants, one new plant, or two new plants. The following table gives the profits for each choice under three states of the economy. The manager assigns the following probabilities to each state of the economy: the economy expands, 20%, the economy contracts, 40%, or the economy is unchanged 40%.

Using the expected value rule which is correct? Building

a. no new plants is better than one.

b. one new plant is better than two.

c. one new plant is equivalent to building two.

d. one new plant is better than none.

e. c and d

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-41 A firm is considering the decision of investing in new plants. It can choose no new plants, one new plant, or two new plants. The following table gives the profits for each choice under three states of the economy. The manager assigns the following probabilities to each state of the economy: the economy expands, 20%, the economy contracts, 40%, or the economy is unchanged 40%.

Using the mean-variance rules, which decision is correct?

a. The firm should build no new plants.

b. The firm should build one new plant.

c. The firm should build two new plants.

d. If deciding only between one or two new plants, the firm should build one.

e. If deciding only between one or two new plants, the firm should build two.

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-42 A firm is considering the decision of investing in new plants. It can choose no new plants, one new plant, or two new plants. The following table gives the profits for each choice under three states of the economy. The manager assigns the following probabilities to each state of the economy: the economy expands, 20%, the economy contracts, 40%, or the economy is unchanged 40%.

Using the coefficient of variation rule, the firm should build

a. no new plants.

b. one new plant.

c. two new plants.

d. cannot tell with this information

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-43 Refer to the following table showing the probability distribution of payoffs from an activity to answer the question below:

What is the expected value?

a. 16.5

b. 28

c. 36.5

d. 42.5

e. 49

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-44 Refer to the following table showing the probability distribution of payoffs from an activity to answer the question below:

What is the variance of the distribution?

a. 136.4

b. 278.8

c. 18.6

d. 346.4

e. 162.3

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-45 Refer to the following table showing the probability distribution of payoffs from an activity to answer the question below:

What is the coefficient of variation for this distribution?

a. 0.39

b. 2.34

c. 0.86

d. 1.02

e. 0.10

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-46 The following table shows the expected value and variance for 5 projects a firm can undertake.

Which of the following is (are) correct?

a. Project B dominates all others

b. Project E dominates all others

c. Project C is the least preferable

d. a and c

1. none of the above

Difficulty: 03 Hard

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-47 The following table shows the expected value and variance for 5 projects a firm can undertake.

Which of the following is (are) correct if the mean−variance rule is used for the decision?

a. Project C is preferable to A.

b. Project E is preferable to B.

c. Project D is preferable to C.

d. all of the above

e. none of the above

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-48 Use the following two probability distributions for sales of a firm to answer the following question:

The expect value of sales for Distribution 1 is _____________.

a. 2,500

b. 2,758

c. 2,800

d. 3,000

e. 4,000

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-49 Use the following two probability distributions for sales of a firm to answer the following question:

The expect value of sales for Distribution 2 is _____________.

a. 2,500

b. 2,758

c. 2,800

d. 3,000

e. none of the above

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-50 Use the following two probability distributions for sales of a firm to answer the following question:

Which distribution is more risky?

a. Distribution 1 has a higher variance than Distribution 2, so Distribution 1 is more risky.

b. Distribution 2 has a higher variance than Distribution 1, so Distribution 2 is more risky.

c. Distribution 2 has a larger standard deviation than Distribution 1, so Distribution 2 is more risky.

d. both b and c

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Reflective Thinking

Blooms: Understand

Learning Objective: 15-03

15-51 Use the following two probability distributions for sales of a firm to answer the following question:

The coefficients of variation for Distributions 1 and 2 are, respectively, ___________ and ___________, so Distribution ______ has MORE risk relative to its mean.

a. 0.22; 0.25; 2

b. 0.22; 0.25; 1

c. 0.31; 0.44; 1

d. 0.31; 0.44; 2

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-52 A firm is making production plans for next quarter, but the manager does not know what the price of the product will be next month. She believes there is a 30 percent chance price will be $500 and a 70 percent chance price will be $750. The four possible profit outcomes are:

Which option has the higher expected profit?

a. Option A

b. Option B

c. Both Options have the same expected profit

d. cannot calculate expected profit with the given information

Difficulty: 02 Medium

Topic: Measuring Risk with Probability Distributions

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-02

15-53 A firm is making production plans for next quarter, but the manager does not know what the price of the product will be next month. She believes there is a 30 percent chance price will be $500 and a 70 percent chance price will be $750. The four possible profit outcomes are:

Which option has the highest (absolute) risk?

a. Option A is riskier than Option B.

b. Option B is riskier than Option A.

c. Both options have the level of risk if the manager is risk averse.

d. cannot calculate risk with the given information

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-54 A firm is making production plans for next quarter, but the manager does not know what the price of the product will be next month. She believes there is a 30 percent chance price will be $500 and a 70 percent chance price will be $750. The four possible profit outcomes are:

Which option is chosen using the coefficient of variation rule?

a. Option A

b. Option B

c. Both options have the same coefficient of variation (to two decimal places).

d. cannot calculate expected profit with the given information

Difficulty: 02 Medium

Topic: Decisions Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-03

15-55 The manager’s utility function for profit is U(π) = 50π, where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

What is the expected profit?

a. $2,000

b. $3,000

c. $4,000

d. $5,000

e. none of the above

Difficulty: 02 Medium

Topic: Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-56 The manager’s utility function for profit is U(π) = 50π, where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

What is the expected utility of profit?

a. −2,500

b. 5,000

c. 15,000

d. 30,000

e. 100,000

Difficulty: 02 Medium

Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-57 The manager’s utility function for profit is U(π) = 50π, where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

The marginal utility of an extra dollar of profit is __________.

a. 0.20

b. 0.30

c. 1.0

d. 10

e. none of the above

Difficulty: 02 Medium

Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-58 The manager’s utility function for profit is U(π) = 10 ln(π), where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

What is the expected profit?

a. $12,000

b. $13,000

c. $14,000

d. $15,000

e. none of the above

Difficulty: 01 Easy

Topic: Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-59 The manager’s utility function for profit is U(π) = 10 ln(π), where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

What is the expected utility of profit?

a. 97

b. 245

c. 462

d. 974

e. 1,033

Difficulty: 02 Medium

Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04

15-60 The manager’s utility function for profit is U(π) = 10 ln(π), where π is the dollar amount of profit. The manager is considering a risky decision with the four possible profit outcomes shown below. The manager makes the following subjective assessments about the probability of each profit outcome:

Given this utility function for profit, the utility of profit is

a. equal to 198 for $20,000.

b. increasing as profit gets larger, so the manager is risk-loving.

c. decreasing as profit gets larger, so the manager is risk-averse.

d. both a and b

e. both a and c

Difficulty: 03 Hard

Expected Utility: A Theory of Decision Making Under Risk

AACSB: Analytical Thinking

Blooms: Apply

Learning Objective: 15-04