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Essay Available:
Pages:
2 pages/β‰ˆ550 words
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3 Sources
Style:
APA
Subject:
Business & Marketing
Type:
Essay
Language:
English (U.S.)
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MS Word
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Topic:

Firm Expansion, Negative Returns, Risk Aversion, and Lottery Tickets

Essay Instructions:

A risk-neutral firm is considering expanding output to supply an expected increase in demand. The cost of this initiative is expected to be $2 million (probability 0.8) or $3 million (probability 0.2). Revenues will be $5 million if demand is indeed strong (probability 0.7) but only $3 million if demand is weak (probability 0.3).
Construct a decision tree to determine whether the firm should undertake the expansion. Then respond to the following items.
1. Explain why a bad outcome can occur from a good decision.
2. Can a firm benefit from a transaction that produces a negative expected return? Explain.
3. Explain risk aversion and risk neutrality, and apply those concepts to this case.
4. State lotteries have a negative expected payout to buyers of tickets. (Much of the proceeds are used to fund education and other programs run by the state). However, many people buy lottery tickets on a regular basis.
a. Is this behavior rational? Explain.
b. Some surveys of state lottery ticket buyers indicate that people are happy to buy a ticket for $1 with a possible prize of $5,000. Fewer, however, would buy a ticket for $100, with a possible prize of $500,000. The ratio of possible prize to ticket cost is the same. Why is the second ticket much less popular?
Your total response (decision tree and answers to the questions) should be a minimum of two pages in length, and both parts should be uploaded as one document. You must use at least one academic source in your answer besides your textbook Samuelson, W. F., & Marks, S. G. (2015). Managerial economics. Hoboken, NJ: Wiley. Any information from outside sources must be cited in APA format.

Essay Sample Content Preview:

Scholarly Activity
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From this case study, it is evident that the risk-neutral firm wants to expand its business and generate more sales by taking a big initiative. The cost of this initiative will be somewhere from $2 to $3 million, and if it achieves significant success, then up to $5 million can be generated in revenues (Samuelson & Marks, 2015). For that, the demand has to be strong enough; in case the demand is not as strong as the firm expects, then it may not be able to generate more than $3 million in revenues.
A Decision Tree for the Case Study
According to Hong Zhang, a decision tree is a graphical representation of resource costs, utilities,and possible outcomes. It is used to display what type of decisions the company should take to gain success and reach a set goal (Zhang, 2005).
From this tree, it is clear that the risk-neutral firm would have to spend some money on advertisements as part of the initiative. If the demand is lower than expected, then none of its efforts will work correctly in the future (Everitt, 2008, p. 121). In order to be successful, the firm must continue with its current advertising agency and sales employees to increase sales. These measures will help the companyboost its performance and bring the business to the next level (Everitt, 2008).
Part 1
In the business world, the competition among brands and firms is always high. Some of them may get significant success while the others end up getting bad outcomes and lose many clients. Undoubtedly, an adverse outcome can occur from right decisions, but we should never lose the hope and keep trying rather than following the footsteps of established brands. Making sound decisions is important, but not all decisions can guarantee success (Samuelson & Marks, 2015). What matters is whether we take the failure seriously and positively and move on or not. For the risk-neutral firm, the new initiative may or may not prove to be successful, but it must continue working hard and consider all available options before getting started (Ilg & Baumeister, 2011).
Part 2
It is safe to say that no company would benefit from transactions that produce negative returns. In fact, they may not risk their money in suc...
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