Question

Suppose that a business is considering two strategies: buy or sell. If economic conditions improve, then the strategies will return, respectively, 10% and 6%. If economic conditions condition unchanged, then the strategies will return, respectively, 1% and 2%. If economic conditions collapse, then the strategies will return, respectively, -8% and -3%. If the probability of improved economic conditions is 80%, then the Buy strategy would be evaluated based on its expected value of ...

Answer 1

The expected value of the Buy strategy, given an 80% probability of improved economic conditions, is 8.6%.

Step-by-step explanation:

In evaluating the expected value of the Buy strategy, we consider the weighted average of its potential returns based on the probabilities associated with each economic condition.

The Buy strategy has a 10% return if economic conditions improve (80% probability), a 1% return if conditions remain unchanged (20% probability), and an -8% return if conditions collapse (0% probability since the sum of probabilities is 100%).

To calculate the expected value, we multiply each return by its probability and sum the results. For the Buy strategy:

`\[ (0.8 * 10\%) + (0.2 * 1\%) + (0 * -8\%) = 8.6\% \]`

Therefore, given an 80% probability of improved economic conditions, the Buy strategy has an expected return of 8.6%.

This analysis helps the business make informed decisions by providing a quantitative measure of the potential outcome of each strategy. It considers the likelihood of different economic scenarios and their corresponding impact on the returns, allowing the business to weigh the risks and rewards associated with the Buy strategy in the given context.