Question

Claire is considering investing in a new business. In the first year, there is a probability of 0.2 that the new business will lose $10,000, a probability of 0.4 that the new business will break even ($0 loss or gain), a probability of 0.3 that the new business will make $5,000 in profits, and a probability of 0.1 that the new business will make $8,000 in profits. a. Claire should invest in the company if she makes a profit. Should she invest? Explain using expected values.

Answer 1

The expected value of business profit is the sum of probability times profit:

... 0.2×(-10,000) + 0.4×0 + 0.3×5,000 + 0.1×8,000

... = -2000 + 1500 + 800

... = 300 . . . dollars

The expected value of the business return is slightly positve, so Claire should invest in the business.