Question

Nana Akosua Owusu – Ansah, a financial manageress for a company is considering two competing investment proposals. For each of these proposals, she has carried out an analysis in which she has determined various net profit figures and has assigned subjective probabilities to the realization of these returns. For proposal A, her analysis shows net profits of GHȼ 20,000.00, GHȼ 30,000.00 or GHȼ 50,000.00 with respective probabilities 0.2, 0.4 and 0.4. For proposal B, she concludes that there is a 50% chance of successful investment, estimated as producing net profits of GHȼ 100,000.00, and of an unsuccessful investment, estimated as a break – even situation involving GHȼ 0.00 of net profit. Assuming that each proposal requires the same Ghana cedi investment, which of the two proposals is preferable solely from the standpoint of expected monetary return?

Answer 1

Answer:

Proposal B

Step-by-step explanation:

This problem can be solved by comparing the expected returns on both options.

The expected return is the sum of the possible outcomes multiplied by its probabilities of occurrence.

For proposal A, the net profits are $20,000, $30,000 and $50,000, with respective probabilities 0.2, 0.4 and 0.4. Then, the expected return can be calculated as:

$E(A)=\sum_{i=1}^3p_iR_i\\\\E(A)=p_1R_1+p_2R_2+p_3R_3\\\\E(A)=0.2*20,000+0.4*30,000+0.4*50,000\\\\E(A)=4,000+12,000+20,000\\\\E(A)=36,000$

The proposal A has a expected net profit of $36,000.

The proposal B has a 50% chance of having a net profit of $100,000 and a 50% of break even (zero net profit). We applied the same calculation for the expected profit and we have:

$E(B)=\sum_{i=1}^2p_iR_i\\\\E(B)=p_1R_1+p_2R_2\\\\E(B)=0.5*100,000+0.5*0\\\\E(B)=50,000$

The proposal B has a expected net profit of $50,000.

Assuming that each proposal requires the same investment, the proposal B has more expected monetary return (GHȼ 50,000) than proposal A (GHȼ 36,000).