Calculating expected profit and utility values
An individual is considering two investment projects.
Project A will return a zero profit if conditions are poor, a profit of $4 if
conditions are good, and a profit of $8 if conditions are excellent. Project B
will return a profit of $2 if conditions are poor. a profit of $3 if conditions
are good, and a profit of $4 if conditions are excellent. The probability
distribution of conditions is as follows:
Conditions: Poor Good Excellent
Probability 40% 50% 10%
a) Using excel, calculate the expected value of each project
and identify the preferred project according to this criterion.
b) Assume that the individual’s utility function for profit
is U(X) = X -0.05X2. Calculate the expected utility of each project and
identify the preferred project according to this criterion.
c) Is this individual risk averse, risk neutral, or risk
seeking? Why?
