An investor has $25,000 in assets and faces a difficult choice between two investments. If he invests in the first opportunity there is a 70% chance that he will increase his assets by $75,000 and a 30% chance that he will increase his assets by $20,000. If he invests in the second option there is a 40% chance that he will increase his assets by $150,000 and a 60% chance that he will increase his assets by $5,000.
(A) Construct a decision tree to help the investor make his decision. Make sure to label all decision and chance nodes and include appropriate costs, payoffs and probabilities.(B) What is the best choice for the investor? Why?(C) Suppose that investor has an exponential utility function for final assets with a risk tolerance parameter equal to $60,000. Which investment opportunity will he prefer in this case? What is his certainty equivalent?
What will be an ideal response?
(B)The decision tree shows the second option is better because it provides a slightly higher EMV ($63,000 vs. $58,500).
(C)The optimal decision would change to the first option, because its certainty equivalent is higher ($52,694 vs. $32,182).
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Managerial accounting reports must be useful to the user of the information
Indicate whether the statement is true or false