Sandra Lives in the Pacific Northwest and Enjoys Walking to and from Work

question 70

Essay

Sandra lives in the Pacific Northwest and enjoys walking to and from work during sunny days. Her utility is sharply diminished if she must walk while it is raining. Sandra's utility function is if she walks and there is no rain and otherwise, if she drives to work and otherwise, and if she walks and it rains and otherwise. Sandra believes that the probability of rain today is ³/₁₀. Given her beliefs, what is her expected utility from walking to work? What is her expected utility from driving to work according to her beliefs? If Sandra maximizes her expected utility according to her beliefs, will she drive or walk to work? Sandra missed the weather report this morning that stated the true probability of rain today is ⁴/₅. Given the weather report is accurate, what is Sandra's true expected utility from walking and driving to work? How much could Sandra increase her expected utility if she read and believed the weather report?

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Definitions:

Real Options

An approach in finance where choices are treated as derivative securities that managers can use to maximise returns while deferring investment decisions.

Expected NPV

An estimation of the Net Present Value of a project or investment, considering the potential outcomes and their probabilities.

Obligation

A legal or financial duty or commitment one party owes to another, often in the form of debts or contractual agreements.

Flexibility Options

Options within contracts or agreements that allow for adjustments based on varying circumstances or needs.