Question

Under normal conditions (60% probability), Financing Plan A will produce a $30,000 higher return than Plan B. Under tight money conditions (40% probability), Plan A will produce $40,000 less than Plan B. What is the expected value of return?

A. $2,800

B. $4,000

C. $4,800

D. $2,000

Answer 1

The expected value of the return, considering the probabilities of normal and tight money conditions, is $2,000, which is option D of the given choices.

Step-by-step explanation:

To calculate the expected value of the return for the financing plans under different conditions, we need to use the probabilities and the returns for each scenario. For Plan A, under normal conditions, which have a 60% probability, the return is $30,000 higher than Plan B. Under tight money conditions, which have a 40% probability, Plan A yields $40,000 less than Plan B. The expected value (EV) is calculated as follows:

EV = (Probability of Normal Conditions × Return under Normal Conditions) + (Probability of Tight Money Conditions × Return under Tight Money Conditions)

EV = (0.6 × $30,000) + (0.4 × (-$40,000))

EV = $18,000 + (-$16,000)

EV = $2,000

Therefore, the expected value of the return is $2,000, which corresponds to answer choice D.