30.03.2023 - 21:05

Mr. Merrill Lynch is planning on investing in stocks. He is considering three different types of stocks, ABC, DEF, and XYZ to choose from under two possible states, good and bad. As a result of favo

Question:

Mr. Merrill Lynch is planning on investing in stocks. He is considering three different types of stocks, ABC, DEF, and XYZ to choose from under two possible states, good and bad.

As a result of favorable stock market conditions, there is a 0.75 probability of good and 0.25 probability of bad state. The table below indicates the profits and losses of investing in the following three stocks under the given states — good and bad.

ABC $75,000$45,000
DEF $90,000 -$30,000
XYZ $35,000$15,000

Using Excel, set up a spreadsheet to find the best decision using:

a. Maximax

b. Maximin

c. Equal likelihood

d. Expected value

d. Expected value is the best decision-making criteria in this scenario. Expected value is calculated by multiplying the probability of each state by the payoff of each decision in that state, then summing those products. In this case, the expected value of each stock is calculated as follows: ABC: (0.75 x $75,000) + (0.25 x$45,000) = $67,500 DEF: (0.75 x$90,000) + (0.25 x -$30,000) =$67,500 XYZ: (0.75 x $35,000) + (0.25 x$15,000) = $30,000 Therefore, based on expected value, investing in either ABC or DEF would be the best decision since they both have an expected value of$67,500. XYZ has a lower expected value of \$30,000, so it would not be the best decision.