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Hi,
In the event we are given situation that is subject to two probabilities how do we combine them. for example the scrap proceed depends on the entrant of new supplier and the change in currency as the sales will be made abroad. Here we are provided with yes or no of each instance and it’s probabilities( the adverse effect will reduce the scrap by 10%) . could you please guide me on how the expected value of the scrap proceed can be performed.
I tried to understand the examiners computations at the back of the text but could not drive any sense.
thanks,sir.It is easier to explain if you refer to a specific past exam question (or a question in the BPP Revision Kit).
However, the expected value of anything is calculated in the same way as it was for Paper PM (and as I show in my lectures for Paper FM). We multiply each of the various possible outcomes by the probably of it occurring, and then add up the results.
I got the question. it exactly read as i described in my above post. only the figures are missing. here it is in full: KAPLAN Q10C.
The scrap value of the machine is 120,000. however, the management has estimated that this value will depend on 2 factors; whether or not new supplier enter the market and the strength of the dollar against other currencies(since sales of used machine will be made abroad). adverse effect will each reduce the scrap value by 10%. the relevant probabilities are as follows:
New supplier: yes 0.4, no 0.6
strong $: yes 0.3, no 0.7.
required: the expected scrap value of the scrap proceeds from machine.
answer: $111,600.There are 4 possible outcomes:
No new supplier, no change in dollar, in which case the outcome is 120,000 with a probability of 0.6 x 0.7 = 0.42.
New supplier, no change in dollar, in which case the outcome is 108,000 with a probability of 0.4 x 0.7 = 0.28
No new supplier, change in dollar, in which case the outcome is 108,000 with a probability of 0.6 x 0.3 = 0.18
New supplier, change in dollar, in which case the outcome is 96,000 with a probability of 0.4 x 0.3 = 0.12.
The expected value is the total of the outcome times the probability in each case.
great. got the glimpse but how did you got 96000 for the last outcome? i guess the 2nd and the third outcome is reduction of the actual proceed by 10%.
Yes. In both cases the 120,000 is reduced by 12,000. So it is 120,000 – (2 x 12,000).
Got it. it was the term ‘adverse’ that i got it wrong. i was looking at strengthening dollar as favourable but no, it is adverse(strong dollar means worsening our trading currency). i see the sense now. thanks a lot.
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