ITC 493 Assessment 2: Task 4

Chapter 11, Exercise 4:

Suppose your organization is deciding which of four projects to bid on. Information on each is in the table below. Assume that all up-front investments are not recovered, so they are shown as negative profits. Draw a diagram and calculate the EMV for each project. Write a few paragraphs explaining which projects you would bid on. Be sure to use the EMV information and your personal risk tolerance to justify your answer.

Answer:

Figure: Decision Tree



Above figure shows probability and outcomes for Project1, Project 2, Project 3, and Project 4.

There is a 50 percent probability that project_1 will earn $120,000 and 50 percent probability that it will lose $50,000. The EMV for Project 1 is $35,000

.5($120,000) - .5(-$50,000) = $60,000- $25,000 = $35,000

There is a 30 percent probability that project_2 will earn $100,000, 40 percent probability that project_2 will earn $50,000 and 30 percent probability that it will lose $60,000. The EMV for Project 2 is $32,000


.3($100,000) + .4($50,000) - .3(-$60,000) = $30,000 + $20,000- $18,000
= $32,000

There is a 70 percent probability that project_1 will earn $20,000 and 30 percent probability that it will lose $5,000. The EMV for Project 1 is $12,500

.7($20,000) - .3(-$5,000) = $14,000- $1,500 = $12,500

There is a 30 percent probability that project_4 will earn $40,000, 30 percent probability that project_4 will earn $30,000, 20 percent probability that it will earn $20,000 and 20 percent probability that it will lose $50,000. The EMV for Project 4 is $15,000

.3($40,000) + .3($30,000) + .2($20,000) - .2(50,000)
= $12,000 + $9,000 + $4,000 - $10,000
= $15,000

From the above calculation Project 1 has a higher EMV so my organization will decide to big for the Project 1.