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Analyzing various proposals by Expected Value Method

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I am planning on building an airport. There are only two parcels, labeled A and B on which the airport could feasibly be built. A corp. knows that once a parcel is chosen the cost of land near the airport will go up so they are considering buying land for an airport hotel adjacent to one of both of these parcels now before a site is chosen. The potential payoffs for the various possible purchases are:
Airport Sited At
Purchase At Site A B
A $13M -$12M
B -$8M $11M
A&B $5M $1M
Neither $0 $0

The company estimates that the probability the airport is sited on parcel A is .4 and the probability that it is sited on parcel B is 0.6. Calculate the expected return for each possible alternative and identify the one that maximizes the expected return.

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Solution Summary

Solution explains the steps for calculating expected profits for various alternatives.

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Solution

Case1
Expected return if he purchases land near site A
E(A) = 13*0.4+(-12)*0.6 =-$2.0million
By this decision, expected loss is $2 ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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