Question

A financial manageress for a company is considering two competing investment proposals. For each of these proposals, she has carried out an analysis in which she has determined various net profit figures and has assigned subjective probabilities to the realization of these returns. For proposal A, her analysis shows net profits of GHȼ 20,000.00, GHȼ 30,000.00 or GHȼ 50,000.00 with respective probabilities 0.2, 0.4 and 0.4. For proposal B, she concludes that there is a 50% chance of successful investment, estimated as producing net profits of GHȼ 100,000.00, and of an unsuccessful investment, estimated as a break – even situation involving GHȼ 0.00 of net profit. Assuming that each proposal requires the same Ghana cedi investment, which of the two proposals is preferable solely from the standpoint of expected monetary return?

Answer 1

Project B is preferable solely from the standpoint of expected monetary return.

Explanation:

Calculations of Expected Returns:

Project A:

Net Profits Probability Expected Returns:

GHȼ 20,000.00 0.2 GHȼ 4,000

GHȼ 30,000.00 0.4 GHȼ 12,000

GHȼ 50,000.00 0.4 GHȼ 20,000

Total Expected Returns GHȼ 36,000

Project B:

Net Profits Probability Expected Returns:

GHȼ 100,000 0.5 GHȼ 50,000

GHȼ 0.00 0.5 GHȼ 0.00

Total Expected Returns GHȼ 50,000

Expected Returns are the returns or income which have been weighed with their probabilities of occurrence. It is used to determine the best outcome given events that have different probabilities of occurring. It is an important measure of returns which helps in deciding the best investment option to pursue.