Question

A manufacturer plans on building a better mousetrap. There is a 60% chance the mouse trap will produce a profit of $200,000 for the company, a 20% chance of a $100,000 profit, and a 20% chance the company will lose $200,000.

Based on this information, should the company build the mousetrap?
A) The expected value is $70,000, so the company should build the mousetrap.
B) The expected value is $85,000, so the company should build the mousetrap.
C) The expected value is $100,000, so the company should build the mousetrap.
D) The expected value is -$70,000, so the company should not build the mousetrap.

Answer 1

Value is calculated by multiplying the chance of each possibility by its value and adding them. The positive sign in value will indicate profit while the negative sign will indicate loss.
Value = 0.6 x 200,000 + 0.2 x 100,000 + 0.2 x (-200,000)
Value = $100,000
The value is high so the company should build the mousetrap. The answer is C.