Global Gas International offers to contract the Halidurton Heavy Construction Corporation to build an oil pipeline fromCanada to New Orleans that will provide Halidurton $500 million in income. The probability that the oil pipeline willleak, causing environmental damage is 0. If so, the legal liability will be $2,500 million.If Halidurton is risk neutral and liable for the damages from a leak, what is the 0 such that it is indifferent betweenaccepting and rejecting the contract?Halidurton is indifferent between accepting and rejecting the contract if 0 equalsrounded to the nearest whole number.)percent. (Enter your response

The net present value or NPV applies to a series of cash flows occurring at various times. The PV of…

using environmental damage is 0. If so, the legal liability will be $2,500 million. urton is risk neutral and liable for the damages from a leak, what is the 0 such that it is indifferent between ng and rejecting the contract? ton is indifferent between accepting and rejecting the contract if 0 equals percent. (Enter your respons

using environmental damage is 0. If so, the legal liability will be $2,500 million. urton is risk neutral and liable for the damages from a leak, what is the 0 such that it is indifferent between ng and rejecting the contract? ton is indifferent between accepting and rejecting the contract if 0 equals percent. (Enter your respons

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.9P

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Market Data Rate of Return Standard Deviation Treasury Bills 4.25% 0.00% S&P 500 12.00% 21.00% Required: Using the information in the table above and the varying risk aversions below, please calculate allocations to the risky and risk-free assets. (Use cells A5 to C6 from the given information to complete this question.) Risk Aversion Percent Allocated to the Market (S&P 500) Percent Allocated to Treasury Bills 4.00 2.00 1.50
Eunice, the industry analyst of H&M, wants to determine the propensity of Major Clothingcompanies toward risk. She was able to determine the utility distribution of H&M, Uniqloand Dickies. For H&M, If the expected payoff of a venture is a loss of 125,000, the utilityvalue is 0.00, if a loss of 75,000, the utility value is .2, if breakeven, the utility value is .5,if gain of 75,000 .8 and if gain of 125,000 utility value is 1. For Uniqlo, if loss of 125,000utility value is 0, if loss of 75,000 utility value is .1, breakeven is .4, if a gain of 75,000,utility value is .7 and if gain of 125,000 utility value is 1. For Dickies, if loss of 125,000,utility value is 0, if loss of 75,000, utility value is .3 breakeven is .6, if gain of 75,000, utilityvalue is .9 and gain of 125,000, utility value is 1. What is the propensity to risk of the threeinternet companies? Explain your graph.
The owner of a ski resort is considering installing a new ski lift that will cost $900,000. Expenses for operating andmaintaining the lift are estimated to be $1,500 per day when operating. The U.S. Weather Service estimates thatthere is a 60% probability of 80 days of skiing weather per year, a 30% probability of 100 days per year, and a 10% probability of 120 days per year. The operators of the resort estimate that during the first 80 days of adequate snow in a season, an average of 500 people will use the lift each day, at a fee of $10 each. If 20 additional days are available, the lift will be used by only 400 people per day during the extra period; and if 20 more days of skiing are available, only 300 people per day will use the lift during those days. The owners wish to recover any invested capital within five years and want at least a 25% per year rate of return before taxes. Based on a before-tax analysis, should the lift be installed?
You are considering a $500,000 investment in the fast-food industry and have narrowed your choice to either a McDonald’s or a Penn Station East Coast Subs franchise. McDonald’s indicates that, based on the location where you are proposing to open a new restaurant, there is a 25 percent probability that aggregate 10-year profits (net of the initial investment) will be $16 million, a 50 percent probability that profits will be $8 million, and a 25 percent probability that profits will be −$1.6 million. The aggregate 10-year profit projections (net of the initial investment) for a Penn Station East Coast Subs franchise is $48 million with a 2.5 percent probability, $8 million with a 95 percent probability, and −$48 million with a 2.5 percent probability. Considering both the risk and expected profitability of these two investment opportunities, which is the better investment? Explain carefully.
You live in an area where there is a possibility of a massive earthquake, so consider purchasing earthquake insurance for your home at an annual cost of $180. The probability of an earthquake damaging your home in the course of a year is 0.001. If this occurs, you estimate that the cost of the damage (fully covered by insurance) will be $160,000. Your total assets (including the house) are worth $250,000. a) Apply the maximum expected value decision rule to determine the alternative (to buy insurance or not) that maximizes the value of your assets after one year. b) You developed a utility function that measures the value of your assets in x dollars (x ≥ 0). This utility function is U(x) = √x. Compare the utility of reducing the total of your assets for the next year by a value equal to the value of the insurance, with the expected utility next year of not purchasing tremor insurance. Should you purchase the insurance?
Exercise 3: Risky Investment Charlie has von Neumann-Morgenstern utility function u(x) = ln x and has wealth W = 250, 000. She is offered the opportunity to purchase a risky project for price P = 160, 000. 1 1 With probability p = 2 the project will be a success and return V > 160, 000. With probability 1 −p = 2 the project will fail and be worthless (i.e. it returns 0). For simplicity assume there is no interest between the time of the investment and the time of its return, that is r = 0 . How large must V be in order for Charlie to want to purchase the risky project? [Hint: What is Charlie’s expected utility is she does not purchase the project? What is Charlie’s expected utility is she purchases the project?]
Farmer Brown faces a 25% chance of there being a year with prolonged drought, with zero yields and zero profit, and he faces a 75% chance of a normal year, with good yields and $100,000 profit. These probabilities are well-known. Suppose that an insurance company offered a drought insurance policy that pays the farmer $80,000 if a prolonged drought occurs. Assume that the farmer’s utility function is u(c) = ln(c). He has initial wealth of $25,000. a Let Y be the expected amount of money that the insurance company will pay Farmer Brown, in the case that Farmer Brown is insured. Compute Y. b. Let X be the most amount of money X Farmer Brown is willing to pay for the insurance. Set up the equation that defines X. Either carefully explain in words what your equation says or put short captions explaining the different parts of your equation. c Determine X to the nearest dollar. d What is the economic intuition on why X > Y?
The current average diesel price is about 145 pence per litre. Your friend firmly believes that the average diesel price will shoot over 160 pence per litre for the Christmas period due to supply and logistics problems while you think, with the mitigation policies from the government, that there is a 60% probability that it will remain below 160 pence per litre. The two of you decide to bet on the outcome with x pounds: if you win, your friend pays you x pounds and vice versa. Your current wealth is 5,000 pounds which is also the maximum amount you can bet. As an expected utility maximiser, should you bet, and why or why not? If you do bet, what is the optimal amount that you should bet to maximise your expected utility?
You live in an area that has a possibility of incurring a massive earthquake, so you are considering buyingearthquake insurance on your home at an annual cost of $180. The probability of an earthquake damagingyour home during one year is 0.001. If this happens, you estimate that the cost of the damage (fully coveredby earthquake insurance) will be $160,000. Your total assets (including your home) are worth $250,000.
The Gorman Manufacturing Company must decide whether to manufacture a component part at its Milan, Michigan, plant or purchase the component part from a supplier. The resulting profit is dependent upon the demand for the product. The following payoff table shows the projected profit (in thousands of dollars): state of nature low demand medium demnad high demand Decision alternative s1 s2 s3 manufacture d1 -20 40 100 purchase d2 10 45 70 The state-of-nature probabilities are P(s1) = 0.35, P(s2) = 0.35, and P(s3) = 0.30. a. Use expected value to recommend a decision. b. Use EVPI to determine whether Gorman should attempt to obtain a better estimate of demand.
The Gorman Manufacturing Company must decide whether to manufacture a component part at its Milan, Michigan, plant or purchase the component part from a supplier. The resulting profit is dependent upon the demand for the product. The following payoff table shows the projected profit (in thousands of dollars): state of nature low demand medium demnad high demand Decision alternative s1 s2 s3 manufacture d1 -20 40 100 purchase d2 10 45 70 The state-of-nature probabilities are P(s1) = 0.35, P(s2) = 0.35, and P(s3) = 0.30. a. A test market study of the potential demand for the product is expected to report either a favourable (F) or unfavourable (U) condition. The relevant conditional probabilities are as follows: P(F|S1)=0.10 P (U|S1)=0.90 P(F|S2)=0.40 P (U|S2)=0.60 P(F|S3)=0.60 P (U|S3)=0.40 A.Compute the probabilities by completing the table Sate of…
The Gorman Manufacturing Company must decide whether to manufacture a component part at its Milan, Michigan, plant or purchase the component part from a supplier. The resulting profit is dependent upon the demand for the product. The following payoff table shows the projected profit (in thousands of dollars): state of nature low demand medium demnad high demand Decision alternative s1 s2 s3 manufacture d1 -20 40 100 purchase d2 10 45 70 The state-of-nature probabilities are P(s1) = 0.35, P(s2) = 0.35, and P(s3) = 0.30. a. A test market study of the potential demand for the product is expected to report either a favourable (F) or unfavourable (U) condition. The relevant conditional probabilities are as follows: P(F|S1)=0.10 P (U|S1)=0.90 P(F|S2)=0.40 P (U|S2)=0.60 P(F|S3)=0.60 P (U|S3)=0.40 What is the expected value of the market research information?…