CHAPTER 8
DECISION ANALYSIS
Internet Case Study: Starting Right
This is an example of decision making under uncertainty. There are two outcomes: a favorable market
and an unfavorable market (event 2). There are four alternatives: do nothing, invest in corporate bonds,
invest in preferred stock, and invest in common stock. The decision table is presented below. Note that for
an investment in corporate bonds 2, the return in a good market is $30,000 × (1+0.13)5 – the initial
investment of $30,000, which is $55,273 – $30,000 = $25,273. Likewise, for an investment in preferred
stock, the return in a good market is (4 × $30,000) – $30,000 = $90,000, and for an investment in common
stock, it is (8 × $30,000) – $30,000 = $210,000.
PAYOFFS
Outcomes
Alternatives
Fav market
Unfav market
Do nothing
$0
$0
See file Ch08 Internet Case Starting Right.XLS for all solutions.
2. Ray Cahn should use a coefficient of realism of 0.11. His best decision is to do nothing.
4. George Yates should use the equally likely criterion. The best decision is to invest in common stock.
6. Julia Day can eliminate the preferred stock alternative and still offer alternatives to risk seekers
(common stock) and risk avoiders (doing nothing or investing in corporate bonds).
Corp bonds
Pref stock
Com stock