University of Tunis Fall 2023
Tunis Business School
Decision & Game Theory
Tutorial 2
Question 1
An investor has three investment plans. The first one yields a return of 10,000 TDN for sure. The
second may yield 22,000 TND with 40% chance, 14,000 TND with 25% chance and -10,000 TND
with 35% chance. The third plan consists on receiving 16,000 TND or 6,000 TND with equal
chances. If it is 16,000 TND, then he has the option to reinvest half the amount with a profit rate
of 40%, 10% or -25% of the invested money with equal chances. The investor wants to determine
which investment plan is the most rewarding.
1. Is it appropriate using the expected monetary value in this context?
2. Represent the problem through a decision tree and solve it.
3. Display the best investment plan
Question 2
Health center of China wants to investigate the possibility to fight against the new disease called
“Corona”. Lab experiments identify three options. Option 1 is already available and may reduce
the death rate by 60%. Option 2 is under testing and validation. It will be available in 2 weeks.
There is 20% risk that it will be obsolete by that time. Otherwise, it may reduce the death rate by
75%. Option 3 requires a full month of improvement and validation. There is 1/3 chance that it
might be too late to introduce it. If not, then there is 2/3 chance that it can reduce the death rate by
100% and 1/3 chance that it will reduce it by 85%. Cost considerations are ignored in these
circumstances. Only one treatment should be introduced for logistics reasons.
1. What could be a legitimate objective in this situation?
2. Identify the best option to introduce.
Question 3
To satisfy some given demand, an entrepreneur has the choice between two investment projects
with the following characteristics: at the end of the second year these investments will have no
residual values. The corresponding costs and cash flows (in dinars) are indicated in the table below:
Investment cost Cash flows
(incurred at the start of year 1) Year 1 Year 2
Project A 180 125 110
Project B 300 190 150
Actually, the above data deals with the most likely values of cash flows which turned out to be
random. Costs are however considered as certain. With some deep analysis, we found out that the
probability distributions of cash flows over the 2 years for both projects are specified below.
Year 1 Year 2
Cash-flow Probability Cash-flow Probability
Project A 110 0.3 100 0.2
1
125 0.5 110 0.6
140 0.2 125 0.2
Project B 170 0.3 130 0.2
190 0.4 150 0.5
215 0.3 165 0.3
While neglecting the discounting factor,
1. Compute the different possible results for each project.
2. Compute the expected value EV of the net profit of each project and rank them on this
basis.
3. Compute the standard deviation of the net profit of each project.
4. Compare both projects based on the criterion EV-k as a function of k.
Question 4
A stock market investor has $500 to spend and is considering purchasing an option contract on
1,000 shares of Apricot Computer. The shares themselves are currently selling for $28.50 per share.
Apricot is involved in a lawsuit, the outcome of which will be known within a month. If the outcome
is in Apricot’s favor, analysts expect Apricot’s stock price to increase by $5 per share. If the
outcome is unfavorable, the price is expected to drop by $2.75 per share. The option costs $500, and
owning the option would allow the investor to purchase 1,000 shares of Apricot stock for $30 per
share. Thus, if the investor buys the option and Apricot prevails in the lawsuit, the investor would
make an immediate profit. Aside from purchasing the option, the investor could do nothing and earn
about 8% on his money, or purchase $500 worth of Apricot shares.
1. Construct the corresponding decision tree.
2. If the investor believes that Apricot stands a 25% chance of winning the lawsuit, should he
purchase the option? What if he believes the chance is only 10%?
3. How large does the probability have to be for the option to be worthwhile?
