An investor has a certain amount of money available to invest now. Three alternative investments are available. The estimated profits ($) of each investment under each economic condition are indicated in the following payoff table:

Based on his own past experience, the investor assigns the following probabilities to each economic condition:
P(Economy declines) = 0.30
P(No change) = 0.50
P(Economy expands) = 0.20
a. Determine the optimal action based on the maximax criterion.
b. Determine the optimal action based on the maximin criterion.
c. Compute the expected monetary value (EMV) for each investment.
d. Compute the expected opportunity loss (EOL) for each investment.
e. Explain the meaning of the expected value of perfect information (EVPI) in this problem.
f. Based on the results of (c) or (d), which investment would you choose? Why?
g. Compute the coefficient of variation for each investment.
h. Compute the return-to-risk ratio (RTRR) for each investment.
i. Based on (g) and (h), what investment would you choose? Why?
j. Compare the results of (f) and (i) and explain any differences.
k. Suppose the probabilities of the different economic conditions are as follows:
1. 0.1, 0.6, and 0.3
2. 0.1, 0.3, and 0.6
3. 0.4, 0.4, and 0.2
4. 0.6, 0.3, and 0.1
Repeat (c) through (j) with each of these sets of probabilities and compare the results with those originally computed in (c)-(j). Discuss.

Transcribed Image Text:

INVESTMENT SELECTION EVENT 腮 Economy declines No change Economy expands 500 1,000 -2,000 2,000 5,000 7,000 1,000 20,000 2,000