You are about to get a legal pay-out of £100,000, but there is a hitch at the last minute and the pay-out depends on the decision of a court. Your solicitor tells you not to worry as there is a 95% chance of you winning the case. Someone offers you a deal, they will pay you £90,000, but they keep anything won in the case. Would you accept the offer?
Accepting the offer would guarantee a pay out of £90,000. Accepting the offer depends on individual circumstances and perception of risk.
Is the guarantee of £90,000 better than the possibility of £100,000 which might be reduced to less than the £90,000?
For the company making the offer a prediction of the company’s earnings can be made by examining what would be expected to happen in 100 runs of the decision.
Gains: 95 wins at £100,000 each time = £9,500,000
Loses: Payments to customers = 100 x 90,000 = £9,000,000
Balance: Profit = £500,000
Even when other items such as court costs are considered it is likely a profit will be made.
To summarise: it is important, when making a decision, to consider the number of times, period of time, or both, that you are going to be exposed to the risk. This is true for financial and other risks.
If you are using this question with some students:
Try to prompt your students’ thinking by asking questions such as:
- Do you think most people would take the deal? Why?
- Why do you think the company is prepared to offer the deal? Is there a profit to be made? How much?
You are aiming to draw out that the company is likely to make this offer to lots of people in similar situations, so, in the long run, they will most likely make a good profit. However, for an individual this is a one-time deal.