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ACCA Strategic Professional · Strategic Business Leader · Identification, assessment and measurement of risk

Orlo Pharma's board is risk neutral at corporate level and evaluates projects by expected value. Project A yields 10m with certainty. Project B yields 40m with probability 0.30 and nil otherwise. Project C yields 20m with probability 0.55 and nil otherwise. The CEO personally prefers the least variable outcome. Which statement is correct?

The risk-neutral board should choose Project B, whose expected value is 12m versus 10m for A and 11m for C. The CEO, who prefers the least variable outcome, would favour A, revealing a difference in risk attitude between manager and owners, which is an agency problem.

  1. AThe board should choose B, with expected value 12m, though the CEO would prefer A, indicating an agency conflict in attitudeCorrect
  2. BThe board should choose A because it has the highest expected value of 10m
  3. CThe board should choose C, with expected value 11m, which is the highest
  4. DThe board should be indifferent between all three projects

Explanation

Expected values: A = 10m, B = 40 x 0.30 = 12m, C = 20 x 0.55 = 11m. A risk-neutral board picks B. The CEO's preference for the certain outcome (A) shows a differing personal risk attitude, which is an agency issue. Choosing A or C ignores the higher expected value of B.

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