Summary 533tree, he decides to assign a .5 probability to each branch. Do you
agree with this procedure or not? Explain.- In 1976, the parents of a seven-year-old boy sued a New York hospital for
$3.5 million. The boy was blinded shortly after he was born two weeks
premature. His parents claimed that hospital doctors administered
excessive oxygen to the baby and that this caused the blindness. The
case went to trial, and just as the jury announced it had reached a
verdict, the lawyers for the two sides arrived at an out-of-court
settlement of $500,000.
a. If you were the parents, how would you decide whether to accept the
settlement or wait for the jury’s decision? What probability
assessments would you need to make? Would you have accepted the
settlement?
b. Answer the questions in part (a), taking the hospital’s point of view. - For five years, a firm has successfully marketed a package of multitask
software. Recently, sales have begun to slip because the software is
incompatible with a number of popular application programs. Thus,
future profits are uncertain. In the software’s present form, the firm’s
managers envision three possible five-year forecasts: maintaining current
profits in the neighborhood of $2 million, a slip in profits to $.5 million,
or the onset of losses to the tune of $1 million. The respective
probabilities for these outcomes are .2, .5, and .3.
An alternative strategy is to develop an “open,” or compatible,
version of the software. This will allow the firm to maintain its market
position, but the effort will be costly. Depending on how costly, the firm
envisions four possible profit outcomes: $1.5 million, $1.1 million, $.8
million, and $.6 million, with each outcome considered equally likely.
a. Which course of action produces greater expected profit?
b. Roughly speaking, which course of action appears to be less risky? If
management were risk averse, would this fact change its preferred
course of action? - A European consortium has spent a considerable amount of time and
money developing a new supersonic aircraft. The aircraft gets high marks
on all performance measures except noise. In fact, because of the noise,
the consortium’s management is concerned that the U.S. government may
impose restrictions on some of the American airports where the aircraft
can land. Management judges a 50–50 chance that there will be some
restrictions. Without restrictions, management estimates its (present
discounted) profit at $125 million; with restrictions, its profit would be
only $25 million. Management must decide now, before knowing the
government’s decision, whether to redesign parts of the aircraft to solve
the noise problem. The cost of the redesign program is $25 million. There
is a .6 chance that the redesign program will solve the noise problem (in
which case, full landing rights are a certainty) and a .4 chance it will fail.
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