Posted by **Devon** on Monday, February 25, 2008 at 10:13pm.

A person must decide whether or not to proceed with a particular investment project. If the project succeeds, She will gain $15 million. If the project fails, she will lose $3 million. She estimates there is a 20% chance that the project will succeed and an 80% chance it will fail.

There is a consultant that could tell her with certainty if the project succeed or fail, but only for a fee. What is the most that she should be willing to pay the consultant for the information? Explain. Assume that she correctly estimated the probabilities of the projectâ€™s likely success and failure.

I AM LOST on this one - can anyone please help?

- Economics -
**economyst**, Tuesday, February 26, 2008 at 8:58am
First, lets assume the person is RISK NEUTRAL -- where the change in utility from an expected dollar loss is equal to the change in utility from an expected dollar gain.

That said, this is simply a comparison of the expected return on the person's investment. Without the consultant, there is a 20% chance she gets 15M and an 80% chance she loses 3M.

E(return) = .2*15 - .8*3 = 0.6

If she hires the consultant, she will only make the investment if its a win. However, taking into account of the fee, her expected return must greater than what she could do without the consultant. So:

E(return) = .2*(15 - F) - .8*F - 0.6

I get the Fee=2.4

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