Answer:
a. Construction of PDF (Probability Distribution Function) for each investment:
Software Company:
x P(x)
$5,000,000 0.10
$1,000,000 0.30
-$1,000,000 0.60
Hardware Company:
x P(x)
$3,000,000 0.20
$1,000,000 0.40
-$1,000,000 0.40
Biotech Firm:
x P(x)
$6,000,000 0.10
$0 0.70
-$1,000,000 0.20
b. Expected value for each investment:
Software Company:
x P(x) Expected value (xP(x)
$5,000,000 0.10 $500,000
$1,000,000 0.30 300,000
-$1,000,000 0.60 -600,000
Total expected value $300,000
Hardware Company:
x P(x) Expected value (xP(x)
$3,000,000 0.20 $600,000
$1,000,000 0.40 400,000
-$1,000,000 0.40 -400,000
Total expected value $600,000
Biotech Firm:
x P(x) Expected value (xP(x)
$6,000,000 0.10 $600,000
$0 0.70 $0
-$1,000,000 0.20 -200,000
Total expected value $400,000
c. The safest investment is the investment in the Hardware Company. Here, the probability of success is highest, with 60%.
d. The riskiest investment is the investment in the Software Company where the probability of failure is highest, with 60%.
e. The investment with the highest expected return on average is the investment in the Hardware Company. It has a total expected return of $600,000.
Step-by-step explanation:
a) Data and Calculations:
Investment amount = $1,000,000
Investment Options:
Software Company:
10% chance of returning $5,000,000
30% chance of returning $1,000,000
60% chance of losing $1,000,000
Hardware Company:
20% chance of returning $3,000,000
40% chance of returning $1,000,000
40% chance of losing $1,000,000
Biotech Firm:
10% chance of returning $6,000,000
70% chance of no profit or loss
20% chance of losing $1,000,000
