13. Ajay is a rational, risk averse investor with $5,000 to invest for one year. He has decided to invest this amount in a high-technology form and has narrowed his choice down to either AB Lid. or XY Ltd, AB is a highly speculative form with good prospects but no estab ished products. XY is a well-established form with stable performance. The payoffs net of amount invested for each firm depend on its next year's performance, as follows Return AB Ltd. $1,089 XY Lid. 5324 High Next Year's Performance Low $ 0 $196 For each firm, Alay assesses prior probabilities of os for each of the high- and low performance states. His utility for his investment return is equal to the square root of the amount of net payoff received Required a. On the basis of his prior probabilities, should Ajay invest in AB Ltd, al or XY Ltd., Show calculations 112 Chapter 3 b. XY Ltd. has just released its annual report. Ay decides to analyze it before investing His analysis shows "good news" (GN). He consults Al, an expert in financial reporting standards who is quite critical of the quality of current GAAP. Al advises that, based on current GAAP, the information system forums annual reports is as follows: Financial Statement Information GN EN 06 Next Year's Performance OS 05 The annual report of AB Ltd. is not due for some time, and nothing else has happened to cause Ajay to change his prior probabilities of AB's next year performance. Which investment should Aay make now? Show calculations C. Concemed by several recent financial reporting failures, the accounting Standard set- ters decide to act. They quickly introduce several new accounting standards, including tighter control over revenue recognition and greater conservatism in asset valuation Also, the securities commission introduces new corporate governance regulations and restrictions on the ability of auditors to engage in non audit Services for their clients Al advises Aay that the information system for annual reports following these new standards and regulations is as follows Financial Statement Information GN 0.8 0.2 High Next Year's Performance Al advises Ajay to ignore the information system in part band instead use this one to revise his prior probabilities of XY Lid's next year's performance based on the GN in its annual report AB Ltd. still has not reported and Ajay's prior probabilities of its performance are unchanged. Which act should Aay now take? Show calculations 13. Ajay is a rational, risk averse investor with $5,000 to invest for one year. He has decided to invest this amount in a high-technology form and has narrowed his choice down to either AB Lid. or XY Ltd, AB is a highly speculative form with good prospects but no estab ished products. XY is a well-established form with stable performance. The payoffs net of amount invested for each firm depend on its next year's performance, as follows Return AB Ltd. $1,089 XY Lid. 5324 High Next Year's Performance Low $ 0 $196 For each firm, Alay assesses prior probabilities of os for each of the high- and low performance states. His utility for his investment return is equal to the square root of the amount of net payoff received Required a. On the basis of his prior probabilities, should Ajay invest in AB Ltd, al or XY Ltd., Show calculations 112 Chapter 3 b. XY Ltd. has just released its annual report. Ay decides to analyze it before investing His analysis shows "good news" (GN). He consults Al, an expert in financial reporting standards who is quite critical of the quality of current GAAP. Al advises that, based on current GAAP, the information system forums annual reports is as follows: Financial Statement Information GN EN 06 Next Year's Performance OS 05 The annual report of AB Ltd. is not due for some time, and nothing else has happened to cause Ajay to change his prior probabilities of AB's next year performance. Which investment should Aay make now? Show calculations C. Concemed by several recent financial reporting failures, the accounting Standard set- ters decide to act. They quickly introduce several new accounting standards, including tighter control over revenue recognition and greater conservatism in asset valuation Also, the securities commission introduces new corporate governance regulations and restrictions on the ability of auditors to engage in non audit Services for their clients Al advises Aay that the information system for annual reports following these new standards and regulations is as follows Financial Statement Information GN 0.8 0.2 High Next Year's Performance Al advises Ajay to ignore the information system in part band instead use this one to revise his prior probabilities of XY Lid's next year's performance based on the GN in its annual report AB Ltd. still has not reported and Ajay's prior probabilities of its performance are unchanged. Which act should Aay now take? Show calculations