Question

A firm supplies aircraft engines to the government and to private firms. It must decide between two mutually exclusive contracts. If it contracts with a private firm, its profit will be $2 million, $1 million, or -$1 million with probabilities .25, .4, and .35, respectively. If it contracts with the government, its profit will be $4 million or -$2.5 million with respective probabilities .4 and .6. Which contract offers the greater expected profit or loss?
a. The private contract offers the greater expected profit.
b. The government contract offers the greater expected profit.
c. Both contracts offer the same expected profit.
d. The private contract results in a greater expected loss.
e. The government contract results in a greater expected loss.

Answer 1

Answer:

Option (A) is correct.

Explanation:

If it contracts with a private firm, for 1st contract,

profit = [(2 × 0.25) + (1 × 0.4) - (1 × 0.35)]

         = 0.55 million dollars

If it contracts with the government, or second contract ,

profit = ($4 × 0.4) - ($2.5 × 0.6)

         = 0.1 million dollars

Therefore, it is clear from the above calculations that the contract with a private will offer more profit as compared to the contract with the government.