Apply the Expected Value Approach to Decision Making

question 10

Multiple Choice

Apply the expected value approach to decision making.
-A land owner is considering a community development project in the southeastern U.S.
He is faced with two alternatives: (1) build detached homes in a planned retirement
Community or (2) build a smaller townhouse / condominium complex. Mortgage interest
Rates will affect his outcomes and the payoff (in $ millions) table is shown below. If the
Probabilities for future mortgage interest rates going up, staying about the same, and
Going down are .35, .50 and .15, respectively, the best decision according to the expected
Value approach is to

• A) build the active retirement community if interest rates go down.
• B) build the active retirement community.
• C) build townhouses / condominiums if interest rates go down.
• D) build townhouses / condominiums.
• E) build either the active retirement community or townhouses / condominiums.

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Definitions:

Even Dollar Increments

A pricing strategy where goods or services are priced in whole dollar amounts rather than including cents.

Complete Stranger

A person whom one does not know or with whom one is not familiar.

Expected Loss

The predicted amount of loss a business might suffer due to risks, calculated as the sum of all possible losses multiplied by their respective probabilities.

Weak Axiom

A principle used in consumer choice theory that stipulates if a consumer chooses bundle A over bundle B when both are affordable, then the consumer should not choose B over A when prices change, holding income constant.