1 A customer has approached a bank for a $50,000 oneyear loan at 12% interest. If the bank does not approve the loan, the $50,000 will be invested in bonds that earn a 6%

annual return. Without further information, the bank feels that there is a 4% chance that the customer will totally default on the loan. If the customer totally defaults, the bank loses $50,000. At a cost of $500, the bank can thoroughly investigate the customer’s credit record and supply a favorable or unfavorable recommendation. Past experience indicates that p(favorable recommendation|

customer does not default)   7 9

7 6



p(favorable recommendation|

customer defaults)  1 4



How can the bank maximize its expected profits? Also find EVSI and EVPI.