NewCrest is looking to invest at most $500,000. The investment can be divided among three options. The return on each option depends on the economic outlook, which is shown in Table 1. For example, if the economic outlook is bright, investing $1 in option I will generate a gain of $3, and investing $1 in option II will result in a loss of $5.
Table 1: Return per dollar invested in the different options
Return per dollar invested in option
Economic Outlook
I
II
III
Bright
3
-5
7
Gloomy
-2
6
-3
(a) Axel, a business executive, proposed two alternatives to NewCrest. One is investing $100,000 in option I, $200,000 in II and $150,000 in III. The other is investing $60,000 in option I, $100,000 in II and $125,000 in III. NewCrest takes a conservative approach to decision-making. That is, it chooses the alternative that maximizes the minimum return produced by the two outcomes of the economic outlook.
Discuss among the two alternatives proposed by Axel, which one NewCrest will choose. Please write clearly alternatives, states of nature and payoffs in a payoff table. Please limit the answer to within one page.
Sample Solution