Case Studies 1. SOLUTION TO STARTING RIGHT CASE, CH. 3, PAGE 110
Case Studies
1. SOLUTION TO STARTING RIGHT CASE, CH. 3, PAGE 110
This is a decision-making-under-uncertainty case. There are two events: a favorable market (event 1) and an unfavorable market (event 2). There are four alternatives, which include do nothing (alternative 1), invest in corporate bonds (alternative 2), invest in preferred stock (alternative 3), and invest in common stock (alternative 4).
The decision table is presented. Note that for alternative 2, the return in a good market is $30,000 (1 + 0.13)5 = $55,273. The return in a good market is $120,000, (4 x
$30,000) for alternative 3, and $240,000, (8 x $30,000) for alternative 4.
Payoff table
Laplace
Hurwicz
Event 1
Event
2
Average
Value
Minimu m Maximu m Value
Alternativ e1 0
0
0.0
0
0
0.00
Alternativ e2 55,273
–
10,00
0
22,636.5
–
10,000
55,273
–
2,819.9
7
Alternativ e3 120,00
0
–
15,00
0
52,500.0
–
15,000
120,000
–150.00
Alternativ e4 240,00
0
–
30,00
0
105,000.
0
–
30,000
240,000
–300.00
Regret table
Maximum
Alternative
Event 1
Event 2
Regret
Alternative 1
240,000
0
240,000
Alternative 2
184,727
10,000
184,727
Alternative 3
120,000
15,000
120,000
Alternative 4
0
30,000
30,000
a. Sue Pansky is a risk avoider and should use the maximin decision approach.
She should do nothing and not make an investment in Starting Right.
b. Ray Cahn should use a coefficient of realism of 0.11. The best decision is to do nothing. c. Lila Battle should eliminate alternative 1 of doing nothing and apply the maximin criterion. The result is to invest in the corporate bonds.
d. George Yates should use the equally likely decision criterion. The best decision for George is to invest in common stock.
e. Pete Metarko is a risk seeker. He should invest in common stock.
f. Julia Day can eliminate the preferred stock
1. SOLUTION TO STARTING RIGHT CASE, CH. 3, PAGE 110
This is a decision-making-under-uncertainty case. There are two events: a favorable market (event 1) and an unfavorable market (event 2). There are four alternatives, which include do nothing (alternative 1), invest in corporate bonds (alternative 2), invest in preferred stock (alternative 3), and invest in common stock (alternative 4).
The decision table is presented. Note that for alternative 2, the return in a good market is $30,000 (1 + 0.13)5 = $55,273. The return in a good market is $120,000, (4 x
$30,000) for alternative 3, and $240,000, (8 x $30,000) for alternative 4.
Payoff table
Laplace
Hurwicz
Event 1
Event
2
Average
Value
Minimu m Maximu m Value
Alternativ e1 0
0
0.0
0
0
0.00
Alternativ e2 55,273
–
10,00
0
22,636.5
–
10,000
55,273
–
2,819.9
7
Alternativ e3 120,00
0
–
15,00
0
52,500.0
–
15,000
120,000
–150.00
Alternativ e4 240,00
0
–
30,00
0
105,000.
0
–
30,000
240,000
–300.00
Regret table
Maximum
Alternative
Event 1
Event 2
Regret
Alternative 1
240,000
0
240,000
Alternative 2
184,727
10,000
184,727
Alternative 3
120,000
15,000
120,000
Alternative 4
0
30,000
30,000
a. Sue Pansky is a risk avoider and should use the maximin decision approach.
She should do nothing and not make an investment in Starting Right.
b. Ray Cahn should use a coefficient of realism of 0.11. The best decision is to do nothing. c. Lila Battle should eliminate alternative 1 of doing nothing and apply the maximin criterion. The result is to invest in the corporate bonds.
d. George Yates should use the equally likely decision criterion. The best decision for George is to invest in common stock.
e. Pete Metarko is a risk seeker. He should invest in common stock.
f. Julia Day can eliminate the preferred stock