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Topic Outline
Facts of the Case
Discussion Questions
who
own
she
new
Discussion Questions
This is a decision-making-under-uncertainty case.
There are two events: a favorable market and an
unfavorable market.
There are four alternatives:
1. invest in corporate bonds;
2. invest in preferred stock;
3. invest in common stock; and,
4. do nothing.
Discussion Questions
Using the future value of a dollar [present value x
(1+interest rate)^number of years], the return in a
good market for corporate bonds in five years is
[30,000(1+0.13)5] = $55,273.06.
The return in a good market for preferred stock is (4 x
$30,000) = $120,000 and for common stock is (8 x
$30,000) = $240,000.
Discussion Questions
The decision table is presented below.
Favorable
Market ($)
Unfavorable
Market ($)
Corporate Bonds
55,273.06
10,000
Preferred Stock
120,000
15,000
Common Stock
240,000
30,000
Do Nothing
Discussion Questions
a. Sue Pansky is a risk avoider and should use the
maximin decision approach. She should do nothing
and not make an investment in Starting Right.
Favorable
Market ($)
Corporate
Bonds
Preferred Stock
Common Stock
Do Nothing
Maximin
($)
55,273.06
Unfavorabl
e
Market ($)
10,000
120,000
240,000
0
15,000
30,000
0
15,000
30,000
0
10,000
Discussion Questions
b. Ray Cahn should use a success probability of 0.11.
The best decision is to do nothing.
Favorable
Market ($)
Corporate
Bonds
Preferred Stock
55,273.06
Unfavorabl
e
Market ($)
10,000
Hurwicz
Value
($)
2,819.96
120,000
15,000
150.00
Common Stock
240,000
30,000
300.00
Do Nothing
Discussion Questions
c. Since Lila Battle will invest in the company, she will
eliminate doing nothing, and apply the maximin
criterion. The result is to invest in corporate bonds.
Favorable
Market
Corporate
Bonds
Preferred
Stock
Common
Stock
Unfavorab
le
Market
55,273.06
10,000
Maximin
($)
10,000
120,000
15,000
15,000
240,000
30,000
30,000
Discussion Questions
d. George Yates should use the equally likely decision
criterion. The best decision for George is to invest in
common stock.
Favorable
Market
Corporate
Bonds
Preferred
Stock
Common
Stock
Do Nothing
Unfavorabl
Equally
e
likely
Market
55,273.06
10,000
22,636.53
120,000
15,000
52,500
240,000
30,000
105,000
Discussion Questions
e. Pete Metarko is a risk seeker. He should invest in
common stock.
Corporate
Bonds
Preferred
Stock
Common
Stock
Do Nothing
15,000
120,000
240,000
30,000
240,000
Discussion Questions
f. Julia Day can eliminate the preferred stock alternative
and still offer alternatives to risk seekers (common
stock) and risk avoiders (investing in corporate
bonds).