Question
Consider the two investments below and their associated payoffs and probability. If your utility function is U(W) = W 0.04W^2 which investment do you prefer?
Consider the two investments below and their associated payoffs and probability. If your utility function is U(W) = W 0.04W^2 which investment do you prefer?
| INVESTMENT A | INVESTMENT B | ||
| $ OUTCOME | PROBABILITY | $ OUTCOME | PROBABILITY |
| 7 | 2/5 | 5 | 1/2 |
| 10 | 1/5 | 12 | 1/4 |
| 14 | 2/5 | 20 | 1/4 |
For Investment B, create new probabilities so that an investor would be indifferent between the two assets. (Hint: it is easier to change just two of the probabilities. So, for instance, leave the $20 payoff at 25% probability and adjust the other two.)
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Managerial Accounting
Authors: Ray H. Garrison, Eric W. Noreen, Peter C. Brewer
13th Edition
978-0073379616, 73379611, 978-0697789938
