Managerial Economics (chapter 13) Risk

Project A

B

State of the economy Boom Normal Recession

Boom Normal Recession

Probability of occurrence Outcome of investment 0.25 $600 0.5 500 0.25 400 Expected profit from project A 0.25 0.5 0.25 expected profit from project B

$800 500 200

Expected value $150 250 100 $500 $200 250 50 $500

Project A Deviation $600-$500=$100 500-500=0 400-500=-100

Deviation squared Probability Deviation squared times probability $10,000 0.25 $2,500 0 0.5 0 10,000 0.25 2,500 variance $5,000 standard deviation $70.71

Project B Deviation $800-$500=$300 500-500=0 200-500=-300

Deviation squared Probability $90,000 0 90,000 variance standard

0.25 0.5 0.25

Deviation squared times probability $22,500 0 22,500 $45,000 $212.13