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ACCA Applied Skills · Performance Management · Dealing with risk and uncertainty in decision-making

A decision tree shows a choice between two projects. Project X has a 60% chance of a $50,000 profit and a 40% chance of a $10,000 loss. Project Y gives a certain profit of $25,000. Using the expected value criterion, which statement is correct?

Project X should be chosen. Its expected value is 0.6 x $50,000 less 0.4 x $10,000, which equals $26,000. This exceeds the certain $25,000 from Project Y, so the expected value criterion favours X.

  1. AChoose Project X, because its expected value is $26,000 against $25,000Correct
  2. BChoose Project Y, because its expected value is $25,000 against $20,000
  3. CChoose Project X, because its expected value is $30,000 against $25,000
  4. DChoose Project Y, because X has an expected value of $24,000

Explanation

EV of X = 0.6 x 50,000 + 0.4 x (10,000) = 30,000 - 4,000 = $26,000. Y is $25,000. X is higher so choose X. Ignoring the loss gives $30,000, which is wrong.

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