Question

• Your report must reflect a coherent reasoning as to your decision.
Case:
An investor, has recently acquired R100 000 in cash through the sale of a previously owned
business. The investor made a profit of R1 000 000 from the sale of the business and has decided
that he/she will invest R100 000 of the R1 000 000 in one of two investment opportunities, namely
Investment 1 or Investment 2. The investor plans to use this investment as part of their retirement
savings, noting that the investor plans to retire in 2 years time. The investor is debt free.
The investor has contracted Mr A. Analyst to assist with the probabilities of profit. Mr A. Analyst has
taken all factors into consideration, and has reported back to the potential investor that following
probabilities apply for Investment 1: (1) there is a 70% probability of achieving a profit of R50 000; (2)
there is a 10% probability of achieving a profit of R10 000; and (3) there is a 20% probability of losing
R20 000. For investment 2 the following applies: (1) there is a 60% probability of achieving a R40 000
profit; (2) there is a 20% probability of achieving a R30 000 profit, and (3) a 20% probability of losing
R10 000.
Mr A. Analyst however is not a registered financial advisor, and cannot advise the investor on which
investment option he/she should take. The investor approaches Old Mutual for advise and asks for a
report to be produced to, advising which option should be taken. Given that Old Mutual is known for
presenting all options, your syndicates role is to produce a report in line with the guidelines above, to
the investor advising which option is most optimal for the investor (expected profit, life-stage etc.).
WHICH ALTERNATIVE SHOULD THE INVESTOR SELECT? ASSUME THAT THE INVESTOR
USES EXPECTED MONETARY VALUE AS THE DECISION CRITERI

Answer 1

Expected value is an calculated value of investment using probabilities of different scenerios. It is calculated by multiplying each of possible outcooome with its respective probability and then adding them all. So here we need to calculate the expected value of both investment alternatives. In expected value as decision criteria we use probabilities for find the expected cash flows. Value of the alternative is higher where expected value of investment is higher.

We have following information

Investment amount = 100000

Investment Alternative 1

S.no	Profit Amount	Probability	Expected monetary value (profit * Probability)
1	50000	70%	35000
2	10000	10%	1000
3	-20000	20%	-4000
			32000

Expected profit considring all probabilities is 32000 for Investment alternative 1.

Investment Alternative 2

S.no	Profit Amount	Probability	Expected monetary value (profit * Probability)
1	40000	60%	24000
2	30000	20%	6000
3	-10000	20%	-2000
			28000

Expected profit considering all probability is 28000 for Investment alternative 2.

According to expected monetary value as decision criteria value of of expected casf flow is higher must be chhosen. As we can see that expected profit is higher from investment alternative 1, most suitable option is investment 1.So investor should choose investment 1.