A state-run company has a complete monopoly over the production of molasses in Mozambique due to trade protections. With these trade protections in place, they earn a profit of $5.8 million. However, the company has just heard that a potential rival firm in a neighboring country is bringing a suit forward in the WTO, alleging that the trade protections violate the WTO's provisions. If the suit is successful, the trade protections will be removed. Without trade protections, the company will earn $0.7 million in profit. The company's lawyers have estimated that the chance that the rival firm's suit succeeds is 33%.

A. What is the expected value of this risk point (that is, the lawsuit) for the company?

B. Now, suppose that the company is approached by an investor who asks to partner with them for a 50/50 profit share. This means if the company decides to partner with the investor, they will earn half their original (with protections) profit. In addition, joining with the investor will convince the WTO that there should be no lawsuit. The tricky part is that the company must decide whether to join the investor before they know the outcome of the lawsuit. Use this information, along with the knowledge that the firm is risk neutral, to decide whether the company should agree to the partnership or not.

C. The WTO informs the company that the company has the option to send a special envoy to perform preliminary hearing, which will give them some information about the likelihood of the outcome of the official hearing. They provide the following information about the outcomes of preliminary and official hearings in the past. First, use the table below and the information in part b. to fill in the blanks in the decision tree. To start you off, a. is asking for the probability that the restrictions are removed given that the preliminary hearing indicated they would be removed. The remainder of the blanks (b., c., d.) follow a similar pattern. The profits at each node also need to be filled in.

Official hearing indicates trade Official hearing indicates trade protections will remain protections will be removed Preliminary hearing indicates 50 4 trade protections will remain Preliminary hearing indicates 10 16 trade protections will be removeda. Protections removed Preliminary hearing removes protections Don't join A Decision Protections remain C b. Join investor .325 E C. .675 Protections removed Don't join B Decision Protections remain D d. Preliminary hearing keeps protections Join investor