You are a riskneutral person whose net worth is 450000 You a

You are a risk-neutral person whose net worth is $450,000. You are thinking about opening a donut franchise, which will require an initial investment of $150,000. If you go ahead, the probability is p, that you w make $500,000, P2 that you wl break even, and p, that you will lose the entire investment. (Note: It is assumed that there are no other possibilities, so p p2 +Ps=1.) Ahai 0.1, P probabilities of the various possible values of net worth as consequences of your two possible courses of action. (Each course of action should be a row in the table.) What is the best decision? = 0.4, and p3 = 0.5. Use tabular form to express the

Solution

Net worth calculation:

Initial investment of $150000 would mean that remaining net worth would be $300000

Expected net worth = 300000 + (0.1 x 500000 + 0.4 x 150000 + 0.5 x 0) = $410000

Not opening a donut franchise would lead to a higher net worth, hence, this would be the best decision.

Decision	Net Worth
Open a donut franchise	$410,000
Don’t open a donut franchise	$450,000