Explain what would be the utility values for the amounts given based on the indifference probabilities?
Chez Paul is contemplating moreover opening another restaurant or expanding its existing location. The payoff table for these two decisions is
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s1
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s2
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s3
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New Restaurant
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-$80K
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$20K
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$160K
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Expand
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-$40K
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$20K
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$100K
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Paul has computed the indifference probability for the lottery having a payoff of $160K with probability p and -$80K with probability (1-p) as follows-
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Amount
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Indifference Probability (p)
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-$40K
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0.4
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$20K
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0.7
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$100K
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0.9
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a. Is Paul a risk avoider and a risk taker or risk neutral? EXPLAIN.
b. Presume Paul has defined the utility of -$80K to be 0 and the utility of $160K to be 80. Explain what would be the utility values for -$40K, $20K, and $100K based on the indifference probabilities?
c. Supposing P(s1) = .4, P(s2) = .3, and P(s3) = .3. Which decision must Paul make using the expected utility approach?
d. Relate the result in part c with the decision using the expected value approach.