Firm A is facing a possible lawsuit by legal firm B. Firm B represents the family of Mr. Smith, who was killed in a motel fire (allegedly caused by faulty wiring). Firm A was the builder of the motel. Firm A has asked its legal team to estimate the likely jury award it will be ordered to pay in court. Expert legal counsel anticipates three possible court outcomes: awards of $1,000,000, $600,000, or $0, with probabilities .2, .5, and .3, respectively. In addition to any awards, firm A’s legal expenses associated with fighting the court case are estimated to be $100,000.
Firm A also has considered the alternative of entering out-of-court settlement negotiations with firm B. Based on the assessments of its lawyers, A envisions the other side holding out for one of two settlement amounts: $900,000 (a high amount) or $400,000 (a more reasonable amount). Each demand is considered equally likely. If presented with one of these settlement demands, firm A is free to accept it (in which case firm B agrees to waive any future right to sue) or reject it and take its chances in court. The legal cost of pursuing a settlement (whether or not one is reached) is $50,000. Determine the settlement or litigation strategy that minimizes firm A’s expected total cost (any payment plus legal fees).