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Advanced Finance Utility Theory Assignment

This document contains 4 questions regarding utility theory and expected monetary value calculations. Question 1 involves calculating the optimal number of items a stockiest should purchase each week to maximize profits based on sales data. Question 2 asks to prepare a payoff table and advise on the number of rooms a hotel complex should build. Question 3 involves determining the best production method a manufacturer should use based on demand probabilities and costs. Question 4 provides two alternatives for a company's next quarter and asks to determine the preferred option based on expected monetary value and expected utility.

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113 views2 pages

Advanced Finance Utility Theory Assignment

This document contains 4 questions regarding utility theory and expected monetary value calculations. Question 1 involves calculating the optimal number of items a stockiest should purchase each week to maximize profits based on sales data. Question 2 asks to prepare a payoff table and advise on the number of rooms a hotel complex should build. Question 3 involves determining the best production method a manufacturer should use based on demand probabilities and costs. Question 4 provides two alternatives for a company's next quarter and asks to determine the preferred option based on expected monetary value and expected utility.

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Hezron
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© © All Rights Reserved
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MSF 506 ADVANCED THEORY OF FINANCE

UTILITY THEORY

ASSIGNMENT ONE

Q1. A stockiest of a particular commodity makes a profit of Kshs. 30 on each sale made within
the same week of purchase; otherwise he incurs a loss of Kshs. 30 on each item. The data on the
past sales are given below:

No. of Items sold 5 6 7 8 9 10 11


within the same week
Frequency 0 9 12 24 9 6 10

a. Find out the optimum number of items the stockiest should buy every week in order to
maximize the profit
b. Calculate the expected value of perfect information

Q2. Leisure Hotels Ltd is planning to build another 700-room complex, it has been suggested
that because the existing hotels average only 70% occupancy on an annual basis, the new
complex should have only 500 rooms. It has been estimated that the cost per room per annum is
Kshs. 21,000. The following data based on demand at similar complexes has been obtained:

Number of Days Daily Demand Average Price per Occupied


Room per Day
Peak Season 200 800 Kshs. 2000
In Between 80 600 Kshs. 1800
Slack Season 85 500 Kshs. 1600
a. Prepare a pay –off table for a complex with 500, 600, 700, and 800 rooms
b. On the basis of this data advise management as to the number of rooms it should include
c. State with reason two further categories of data that would be useful before making the
final decision

Q3. The annual demand for a seasonal product follows the distribution shown here.

Demand (Units) 3,000 3,500 4,000 4,500 5,000


Probability 0.10 0.20 0.30 0.30 0.10
The manufacturer of this item can produce it by one of the three methods:

a. Using the existing equipment at a cost of Kshs. 8 per unit


b. Buy special equipment for Kshs. 22,000 whose salvage value at the end of the year would
be Kshs. 2000. The variable cost per unit using this equipment is Kshs. 2
c. Buy special equipment for Kshs. 90,000 which would be depreciated on straight line
basis over a period of 4 years. The variable cost using this equipment is Kshs. 1.20 per
unit.

DR. WAFULA 1
Which method of production should the manufacturer follow in order to maximize profit,
assuming that production must meet all the demand?
Q4. The Operations Manager of Qwetu limited has two alternatives to choose from for the next
quarter.

a. To take a contract to supply an item to a company this would result in a sure profit of
Kshs.500,000
b. To make and introduce a new product in the market. The likely profit/loss possibilities along
with the likely probabilities are also given. Also shown are the utility values associated with
the various profit levels.
Profit/Loss -450000 0 500,000 800,000 1,600,000
Probability 0.1 0.2 0.3 0.3 0.1
Utility (Utils) -0.50 0 0.45 0.70 1.20
Determine which course of action would be preferred by the manager when she wants to
maximize:

i. The EMV and


ii. The expected utility

DR. WAFULA 2

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