Question

​Micro-Pub, Inc., is considering the purchase of one of two microfilm​ cameras, R and S. Both should provide benefits over a​ 10-year period, and each requires an initial investment of

​$3,000.

Management has constructed the following table of estimates of rates of return and probabilities for​ pessimistic, most​ likely, and optimistic​ results

Camera R		Camera S
	Amount	Probability	Amount		Probability
Initial investment	​$3,000	1.00	​$3,000		1.00
Annual rate of return
Pessimistic	21​%	0.21	16​%		0.23
Most likely	27​%	0.46	29​%		0.57
Optimistic	31​%	0.33	32​%		0.20

Determine the value of the expected return for each camera. ?

Answer 1

Camera R:

Probability of Pessimistic = 0.21
Return during Pessimistic = 21%
Probability of Most Likely = 0.46
Return during Most Likely = 27%
Probability of Optimistic = 0.33
Return during Optimistic = 31%

Expected Return = Probability of Pessimistic * Return during Pessimistic + Probability of Most Likely * Return during Most Likely + Probability of Optimistic * Return during Optimistic
Expected Return = 0.21 * 21% + 0.46 * 27% + 0.33 * 31%
Expected Return = 27.06%

Camera S:

Probability of Pessimistic = 0.23
Return during Pessimistic = 16%
Probability of Most Likely = 0.57
Return during Most Likely = 29%
Probability of Optimistic = 0.20
Return during Optimistic = 32%

Expected Return = Probability of Pessimistic * Return during Pessimistic + Probability of Most Likely * Return during Most Likely + Probability of Optimistic * Return during Optimistic
Expected Return = 0.23 * 16% + 0.57 * 29% + 0.20 * 32%
Expected Return = 26.61%