Choose between the two projects below. What is the EMV for each? Looking at your own personal Risk Utility Function, which project would you select and why?

Problem Set #2: Decision Tree

This problem set covers material for Week 7, Risk Analysis. Decision Tree Analysis is an important aspect of Risk Management. It is mentioned, but not treated extensively in the text.

INSTRUCTIONS:

• Review attached instructor video & slides for reference
• Only problem #1 is required (#2 is optional)
• Please show your work (and not just the answers) to get full credit.
• Will review in week 7 class session.

Prob. 1. You must choose between the two projects below. What is the EMV for each? Looking at your own personal Risk Utility Function, which project would you select and why?Project 1 has a 70% chance of earning $500,000, and a 30% chance of losing $100,000. Project 2 has a 20% chance of earning $2 million, a 20% chance of earning $1 million, and a 60 percent chance of losing $500,000.

Prob. 2. You have $1,000,000 worth of equipment at the job site and wish to minimize your risk of direct property damage by taking out an insurance policy. The insurance company provides you with their statistical data as shown below.If the insurance company uses expected monetary value to calculate premiums, then how much would you expect the premium to be, assuming the insurance company adds on $300 for handling and profit? (Hint: Remember that translating a probability of 0.02% to a decimal equivalent equals 0.0002.)