Imagine there is a company owned by Jane that is worth somewhere between $0 and $50k. Jane knows the exact value of the company, but all you know is that the company ranges in value from 0 to $50k. Further, assume a uniform probability distribution, meaning that all possible values from 0 to $50k are equally likely. No matter what the company is actually worth to Jane, however, the company is worth 50% more to you than it is to Jane. Let's also imagine that you are risk neutral (all you care about is your expected gain, so you are not averse to risk). You can also assume no transaction costs and no liquidity constraints.

a. What is the take-it-or-leave-it offer that you would give to Jane that maximizes your expected profit?

b. Now imagine instead of a uniform probability distribution, you think there are just 2 values of the company. Either the company is worth $30k or the company is worth $50k. You think there is an equally likely chance of both of these. The company is still worth 50% more to you than it is to Jane. Now what would be your take-it-or-leave-it-offer for Jane?

Now imagine all of the same info as in part b), but the company is worth 150% more to you than it is to Jane. Now what is your take-it-or-leave-it-offer for Jane?

Now imagine that everything is the same as in part b) again. How much more does the company have to be worth to you than to Jane in order for you to be willing to make a non- zero offer?

Answer rating: 100% (QA)

a Given the uniform probability distribution the expected value of the company to Jane is 25k Sinc... View the full answer