John Is Trying to Decide Whether to Expand His Business

question 44

Multiple Choice

John is trying to decide whether to expand his business or not.If he continues his business as it is,with no expansion,there is a 50 percent chance he will earn $100,000 and a 50 percent chance he will earn $300,000.If he does expand,there is a 30 percent chance he will earn $100,000,a 30 percent chance he will earn $300,000 and a 40 percent chance he will earn $500,000.It will cost him $150,000 to expand.John should:

• A) expand, since he expects to earn $320,000 by expanding, and it will only cost him $150,000 to do so.
• B) not expand, because there is a chance John will earn the same as if he didn't expand and would be out the $150,000 investment.
• C) not expand, since he expects to earn $120,000 more by expanding than not, and it will cost him $150,000 to do so.
• D) expand, since he has a 70 percent chance of earning more than the cost of expansion.

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Definitions:

Treasury Stock

Shares that were issued and subsequently reacquired by the issuing company, reducing shareholders' equity.

Stockholders' Equity

The ownership interest of shareholders in a company, calculated as the company's total assets minus its total liabilities.

Treasury Stock

Shares that were once part of the float and outstanding shares, but were bought back by the company, reducing the amount of stock on the open market.

Common Stock

A type of equity security that represents ownership in a corporation, with rights to vote on corporate matters and receive dividends.