Florentino Allers is the production manager of Electronics Manufacturer. Due to limited capacity, the company can only produce one of two possible products:

An industrial motherboard with a 75% probability of making a profit of $1 million and a 25% probability of making a profit of $120,000.

A regular motherboard with a 100% chance of making a profit of $660,000.

Florentino will get a 20% bonus from his department. Florentino has the responsibility to choose between the two products and is more of a risk-taker, more so than most of the top management at Electronics Manufacturer.

a. Which option is Florentino more likely to choose and why?

b. Which option would the company be more likely to choose and why?

c. What changes should the company make to Florentino's compensation to avoid unnecessary risks?

Question

Ingrid Acosta

Business

5 May, 01:49

Florentino Allers is the production manager of Electronics Manufacturer. Due to limited capacity, the company can only produce one of two possible products:

An industrial motherboard with a 75% probability of making a profit of $1 million and a 25% probability of making a profit of $120,000.

A regular motherboard with a 100% chance of making a profit of $660,000.

Florentino will get a 20% bonus from his department. Florentino has the responsibility to choose between the two products and is more of a risk-taker, more so than most of the top management at Electronics Manufacturer.

a. Which option is Florentino more likely to choose and why?

b. Which option would the company be more likely to choose and why?

c. What changes should the company make to Florentino's compensation to avoid unnecessary risks?

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Answers (1)

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India Jones · Answer 1

A.

Florentino will choose the industrial motherboard since he is a risk-taker, and a 75% chance of a $1 million profit is much higher than the $ 690000 (even though there is a 25% chance of a $180,000 profit with the industrial motherboard).

B.

The company, being a lower risk taker than Florentino, would prefer the regular motherboard because of the certainty of earning $690000 While the expected value of the industrial motherboard is 105000 higher, the potential difference of $510000 is not enough to offset the higher risk (25% chance) of only earning $180,000.

C.

The company should reduce the size of the bonus and increase the salary, thus leveling the playing field when it comes to risk-taking.