Kholodny plc installs ventilation systems At present its ord

Kholodny plc installs ventilation systems. At present its order book is rather thin and it has no work for the forthcoming period. It has been offered two contracts abroad, of which it can take only one. The first contract is to install a ventilation system in the Presidential Palace of the republic of Sloochai. The contract should earn the company a profit of 8m but the country is unstable and there is s 70% probability that the president will be overthrown before the work is finished. If the president is overthrown his opponents are not expected to pay for the work and the company would face a loss of 0.5m. The second contract is to install a ventilation system in an administration building in the republic of Parooka. The company can expect a profit of 6m from this contract unless the local currency is devalued during the completion of the project in which case the profit will fall to 3m. Financial experts put the probability of devaluation at 0.5.

a) Construct a decision tree to portray the decision tree to portray the situation the company faces.

b) Calculate the expected monetary value for each project and use them to suggest which project the company should take.

c) The president of Sloochai gives a key opponent a prominent post in his government. As a result the probability of the president being overthrown is revised to 40%. Does this new information alter the advice you gave in your answer to b? If so, why?

Solution

Decision tree Revised prob 0.3 President overthrown -0.15 0.4 -0.2 0.7 President not overthrown 5.6 0.6 4.8 0.5 Devalued 3 3 0.5 Not devalued 1.5 1.5 Expected value 9.95 9.1 As expected value is positive in both the cases, advisable to proceed with the project in both the cases.