EIEIO.com is a new website devoted to providing news to farmers. The company plans to make money by selling banner ads and providing links to companies that wish to sell items to this market. To run its website, the server the company is considering purchasing is from one of four manufacturers, IBM, H-P, Compaq, or Dell. Since the company has limited funding, this server will have to meet its needs for the next six months.
The company estimates that its profits over the six- month period will be a function of the server purchased and the average number of “hits” per hour that the website generates. The following payoff table (showing total estimated profits over the six-month period in $ 10,000s) has been developed to assist management in determining which model of server to purchase.
a. Would you characterize management as risk averse, risk loving, or risk neutral?
b. Suppose management believes the following probabilities hold for the states of nature: P(10) = .05, P(25) = .15, P(50) = .40, P(100) = .30, and P(300) = .10. Which server should the firm purchase if it uses the expected utility criterion for decision making?