Page 304 - P1 Integrated Workbook STUDENT 2018

Subject P1: Management Accounting

5.5 The answer is $25,000.

Point A represents a decision point. If the decision is taken to licence then there
is a value of $10k.

The other decision is to further invest – which appears to have a cost of $8k.
But this then opens up the chance point where there is an 80% chance of
making $40k and a 20% chance of making $5k. So this decision to further
invest would have an expected value of:

= -8k + [(0.80 × 40) + (0.20 × 5)] = $25k

Therefore, the decision to further invest is worth more than the licencing option.
The company would choose to further invest and would make $25k. This is the
value at point A

5.6 D

A regret table shows the shortfall from the maximum contribution that could be
earned at each demand level. For a demand level of 40 units the maximum
possible profit is $9,000. However, if only 20 units are produced then the return
will be only $7,500. This represents a potential shortfall of $1,500 at Point X.

5.7 The answer is $22,000.

True?

As standard deviation increases risk decreases

Perfect information is always correct 

A risk neutral investor typically ignores the range of possible
outcomes 

Probabilities used in expected value calculations are objective

Imperfect information has no value

As standard deviation increases risk increases. Probabilities used in expected
value calculations are subjective, not objective. Imperfect information that
increases the overall expected value has some value.

The other statements are true.

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