Question

1. Mr. Sokol and Ms. Rivera are two candidates for the same advertising manager position.
   
   Sokol has a consistent history of designing and implementing successful marketing campaigns. You as the potential employer have 100% certainty he will succeed if you hire him and bring in $800,000 more revenue each year.
   
   Rivera is a magazine writer and editor who has no experience in advertising but wants to break into this field. She has a track record of succeeding in all her previous jobs, speaks well, and writes persuasively. If you hire her, you feel she has a 60% chance of succeeding and bring $1,200,000 revenue to you company this year and a 40% chance of losing $500,000 for your firm this year.
   
   Each candidate if hired will be paid $100,000 and you only have one opening. If the candidate is successful, you expect him or her to stay with your company for three years. If the candidate lost money for your company, you would terminate him of her after the first year.
   
   A) Please determine the expected value of each candidate if hired.
   
   

B) If you are risk neutral, which candidate would be the better hire?

Answer 1

Here we ignore time value of money in the given question as we are not provided with any required data. Alternatively, we can assume any rate and calculate the value of each candidate.

Sokol will earn $800,000 a year with 100% certainty and will be paid $100,000 a year. So, his value per year is $700,000. Total expected value for 3 years is $2,100,000 ($700,000 x 3 years).

Rivera

Alternative 1 : If she becomes successful in first year, we will continue her for 3 years and she will generate the same $1,200,000 for remaining years

The total revenue for 3 years = 1,200,000 x 3 = 3,600,000

Total payments made to her = 100,000 x 3 = 300,000

Total Net Revenue = $3,300,000

Alternative 2 : If she becomes unsuccessful after first year, she will be removed from her place and there is no revenue for 2nd and 3rd year

Revenue for 1st year = $500,000

Payment for 1st year = $100,000

Net Revenue for 1st year = $400,000

Expected net revenue = 60% x 3,300,000 + 40% x 400,000

= $2,140,000

Based on this expected revenue, we would hire Ms.Rivera as expected value from hiring her is higher ($2,140,000) than the Mr.Sokol's expected value ($2,100,000).

Note :

We assumed that, if Ms.Rivera didn't succeed the first year, she will be removed and no other person will be appointed for 2nd and 3rd year (so no extra income for those years). If she is successful for first year then she will generate the same amount of $1,200,000 for remaining two years.