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Chez Paul is contemplating either opening another restaurant or expanding its existing location. The payoff table for these two decisions is:

s1 s2 s3
New Restaurant -\$80K \$20K \$160K
Expand -\$40K \$20K \$100K

Paul has calculated the indifference probability for the lottery having a payoff of \$160K with probability p and -\$80K with probability (1-p) as follows:

Amount Indifference Probability (p)
-\$40K .4
\$20K .7
\$100K .9

a. Is Paul a risk avoider, a risk taker, or risk neutral? EXPLAIN.

b. Suppose Paul has defined the utility of -\$80K to be 0 and the utility of \$160K to be 80. What would be the utility values for -\$40K, \$20K, and \$100K based on the indifference probabilities?

c. Suppose P(s1) = .4, P(s2) = .3, and P(s3) = .3. Which decision should Paul make using the expected utility approach?

d. Compare the result in part c with the decision using the expected value approach.

#### Solution Summary

The solution covers topics such as payoff tables, indifference probability, risk avoidance, risk taking, risk neutral, utility, expected utility approach and the expected value approach. Attached as Excel.

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