Case Studies 1. SOLUTION TO STARTING RIGHT CASE, CH. 3, PAGE 110
This is a decision-making-under-uncertainty case. There are two events: a favorable market (event 1) and an unfavorable market (event 2). There are four alternatives, which include do nothing (alternative 1), invest in corporate bonds (alternative 2), invest in preferred stock (alternative 3), and invest in common stock (alternative 4). The decision table is presented. Note that for alternative 2, the return in a good market is $30,000 (1 + 0.13)5 = $55,273. The return in a good market is $120,000, (4 x $30,000) for alternative 3, and $240,000, (8 x $30,000) for alternative 4. Payoff table Laplace Event 1 Alternativ e1 Alternativ e2 Alternativ e3 Alternativ e4 0 55,273 Event 2 0 – 10,00 0 – 15,00 0 – 30,00 0 Average Value 0.0 22,636.5 Minimu m 0 – 10,000 – 15,000 – 30,000 Maximu m 0 55,273 Hurwicz Value 0.00 – 2,819.9 7 –150.00

120,00 0 240,00 0

52,500.0

120,000

105,000. 0

240,000

–300.00

Regret table Maximum Alternative Alternative 1 Alternative 2 Alternative 3 Alternative 4 Event 1 240,000 184,727 120,000 0 Event 2 0 10,000 15,000 30,000 Regret 240,000 184,727 120,000 30,000

a. Sue Pansky is a risk avoider and should use the maximin decision approach. She should do nothing and not make an investment in Starting Right. b. Ray Cahn should use a coefficient of realism of 0.11. The best decision is to do nothing. c. Lila Battle should eliminate alternative 1 of doing nothing and apply the maximin criterion. The result is to invest in the corporate bonds. d. George Yates should use the equally likely decision criterion. The best decision for George is to invest in common stock.

e. Pete Metarko is a risk seeker. He should invest in common stock. f. Julia Day can eliminate the preferred stock alternative and still offer alternatives to risk seekers (common stock) and risk