King Inc a successful Midwest firm is considering opening a

King, Inc., a successful Midwest firm, is considering opening a branch office on the west coast. Under normal economic conditions, with a 45% probability of occurring, King can expect to earn a net income of $50,000 per year. In a mini-recession, at 25% probability, King will earn $20,000. In a severe recession, at a 20% probability, King will lose $10,000. There is also a slight probability (10%) that King will lose $300,000 if the expansion fails and the branch office must be closed. What is the weighted Average for the different variables and should King open a branch office in California?

Solution

Weighted Average are the Probabilities only.

Situation Probabilty / Weights Income $ Weighted Income $

Normal Economic Conditions 0.45 50,000 22,500

Mini- Recession 0.25 20,000 5,000

Severe Recession 0.20 10,000     2,000

Expansion Fails 0.10 - 300,000 -30,000

Net Flow = - $ 500

Since there is a net outflow King Should not open the branch office.