Question

Global Studios is thinking of producing a megafilm, Aqua World, which could be a megahit or a megaflop. Profit is uncertain because of two reasons: (1) the cost of producing the firm may be low or high, and (2) the market reception for the film may be strong or weak. There is a 0.5 chance of low cost (C) and a 0.5 chance of high costs. The probability of strong demand (D) is 0.4; the probability of low demand is 0.6. The studio's profits (in millions of dollars) for the four possible outcomes are shown in the table Low C/Strong D Low C/Weak D High C/Strong D High C/Weak D 80 10 0 -70 1. Draw the decision tree for Global Studios. 2. Assuming Global Studios is risk neutral, should the studio produce the film? 3. Assuming Global Studios is risk averse, should the studio produce the film?

Answer 1

1.

			costs
		low		high
		0.5		0.5
			demand
		strong	weak	strong	weak
		0.4	0.6	0.4	0.6
	profit	80	10	0	-70

2.Since the studio is risk neutral it should produce the film.

3.Since the studio is risk averse so it should not produce the film.