Question

Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:

Equipment	Favorable Market ($) with probability 70%	Unfavorable Market ($) with probability 30%
Sub 100	300,000	–200,000
Oiler J	250,000	–100,000
Texan	75,000	–18,000

For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is unfavorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.

Although Ken Brown is the principal owner of Brown Oil, his brother Bob is credited with making the company a financial success. Bob is vice president of finance. Bob attributes his success to his pessimistic attitude about business and the oil industry.

Question 1 of 9 If Bob would want to base his decision on the Maximin criterion, then which equipment would he choose? A. Sub 100 B. Oiler J C. Texan D. The same as his brother Ken's choice

Question 2 of 9 Based on the above information, the Expected Monetary Value (EMV) of Sub 100 is   . (Please round to a whole dollar.)

Question 3 of 9 Based on the above information, the Expected Monetary Value (EMV) of Oiler J is   . (Please round to a whole dollar.)

Question 4 of 9 If Ken would want to maximize the Expected Monetary Value (EMV), then he should choose __________. A. Sub 100 B. Oiler J C. Texan Reset Selection

Question 5 of 9 If Ken believes that Sub 100 cannot get $300,000 even in a favorable market, then this figure needs to be at least   less for Ken to change his decision. (Please round to a whole dollar.)   Hint: You may want to use the What-If-Analysis Goal Seek Tool in Excel as described in Week 1 PPP Slides (1-30).   Mark for Review What's This?

Answer 1

Brown Oil , Inc	Favorable Market		Unfavorable Market
Equipment	Probability	Profit	Probability	Profit
Sub 100	70%	$          300,000	30%	$       (200,000)
Oiler J	70%	$          250,000	30%	$       (100,000)
Texan	70%	$            75,000	30%	$         (18,000)

Ans 1.
Maximin Criterion
Equipment	Profit in Unfavorable Market
Sub 100	$       (200,000)
Oiler J	$       (100,000)
Texan	$         (18,000)
The maximum payout possible in unfavorable outcomes
is from Equipment Texan.
So Bob would chose Texan under Maximin criterion.

EMV Value Calculation
Brown Oil , Inc	Favorable Market		Unfavorable Market		EMV =Pf*I+Pu*L
	Pf	I	Pu	L
Equipment	Probability	Profit	Probability	Profit
Sub 100	70%	$          300,000	30%	$       (200,000)	$                      150,000	Ans 2.
Oiler J	70%	$          250,000	30%	$       (100,000)	$                      145,000	Ans 3.
Texan	70%	$            75,000	30%	$         (18,000)	$                        47,100

Ans 4.
Maximum EMV is provided by Sub 100, so based on EMV , Ken will choose Sub 100
Ans 5.
The next best EMV is $145,000 from Oiler J. The difference is $5000
So The Profit from Sub 100 needs to be $5000/70% =$7,143 less than $300,000 so that the EMV of Sub 100 and Oiler J are equal
So the Profit from Sub 100 needs to be at least $7144 less for Ken to change his decision.