The head of operations for a movie studio wants to determine which of two new scripts they should select for their next major production. She feels that script #1 has a 70% chance of earning $100 million over the long run, but a 30% chance of losing $20 million. If this movie is successful, then a sequel could also be produced, with an 80% chance of earning $50 million, but a 20% chance of losing $10 million. On the other hand, she feels that script #2 has a 60 % chance of earning $120 million, but a 40% chance of losing $30 million. If successful, its sequel would have a 50% chance of earning $80 million and a 50% chance of losing $40 million. As with the first script, if the original movie is a "flop," then no sequel would be produced.
What would be the total payoff is script #1 were a success, but its sequel were not?
A) $150 million
B) $100 million
C) $90 million
D) $50 million
E) $−10 million

Question

Quizplus · Accepted Answer

If script #1 is successful, the payoff would be $100 million. However, if its sequel were not produced or was a flop, there would be no further payoff. Therefore, the total payoff would be $100 million. However, since there is a 30% chance of losing $20 million with script #1, the expected value of choosing this script would be:
Expected Value = ($100 million x 0.7) + (-$20 million x 0.3) = $64 million
In comparison, the expected value of choosing script #2 would be:
Expected Value = ($120 million x 0.6) + (-$30 million x 0.4) = $54 million
Therefore, script #1 has a higher expected value and would be the best choice.

The Head of Operations for a Movie Studio Wants to Determine