Key considerations as Allied develops its strategy for disposing of the case are the probabilities associated with John’s response to an Allied counteroffer of $400,000 and the probabilities associated with the three possible trial outcomes. John will accept a counteroffer of $400,000 is 0.10, John will reject the counteroffer of $400,000 is 0.40, and John will make a counteroffer of $600,000 is 0.50. If the case goes to court, they believe the jury will award John damages of $1,500,000 is 0.30, award John damages of $750,000 is 0.50 and the probability the jury will award John nothing is 0.20.
What would a risk profile of recommended strategy be? Examples please.
To determine the risk profile of the recommended strategy, we need to assess the potential outcomes and their corresponding probabilities. Let's break down the possibilities and calculate the expected values:
1. John accepts the counteroffer of $400,000 (Probability: 0.10):
- Expected Value: $400,000
2. John rejects the counteroffer of $400,000 (Probability: 0.40):
- John makes a counteroffer of $600,000 (Probability: 0.50):
- Expected Value: $600,000
- The case goes to trial:
- The jury awards John damages of $1,500,000 (Probability: 0.30):
- Expected Value: $1,500,000
- The jury awards John damages of $750,000 (Probability: 0.50):
- Expected Value: $750,000
- The jury awards John nothing (Probability: 0.20):
- Expected Value: $0
To calculate the overall expected value of the strategy, we need to consider the weighted average of the expected values:
Expected Value = (0.10 * $400,000) + (0.40 * ((0.50 * $600,000) + (0.30 * $1,500,000) + (0.50 * $750,000) + (0.20 * $0)))
By calculating the above expression, we can find the expected value, which represents the average outcome (in monetary terms) for the recommended strategy.
Additionally, we can assess the risk profile based on the variability of outcomes. A higher degree of variability indicates more risk. One way to measure this is through the standard deviation of the expected values. However, to calculate a precise standard deviation, we would need more data about the potential outcomes.
Considering these calculations, a risk profile of the recommended strategy could be described as moderately risky due to the uncertainty and variability associated with the trial outcomes and John's response to the counteroffer. Examples of the risk profile could be:
1. Conservative Approach: Allied may choose to offer John a settlement slightly higher than the expected value, such as $450,000, to mitigate the risk of a trial and potential higher damages. This minimizes potential losses but may result in a higher expenditure.
2. Aggressive Approach: Allied may decide to reject John's counteroffer of $400,000 and proceed to trial, hoping for the jury to award lower damages or nothing at all. This approach carries higher risk and could result in higher losses if the trial outcomes are unfavorable.
These examples reflect how the risk profile can influence the recommended strategy by choosing a more cautious or a more aggressive approach based on the potential outcomes and their probabilities.