question archive Mary is thinking of suing the manufacturer of her car because of a defect that she believes caused her to have an accident, and kept her out of work for a year
Mary is thinking of suing the manufacturer of her car because of a defect that she believes caused her to have an accident, and kept her out of work for a year
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Mary is thinking of suing the manufacturer of her car because of a defect that she believes caused her to have an accident, and kept her out of work for a year. She is suing the company for $3.5 million. The company has offered her a settlement of $700,000, of which Mary would receive $600,000 after attorneys’ fees. Her attorney has advised her that she has a 50% chance of winning her case. If she losses, she will incur attorneys’ fees and court costs of $75,000. If she wins she is not guaranteed of her full requested settlement. Her attorney believes that there is a 50% chance she could receive the full settlement, in which case Mary would get $2 million after her attorney takes his cut, and a 50% chance that the jury will award her a lesser amount of $1,000,000, of which Mary would get $500,000. Using decision tree analysis, decide if Mary should sue the manufacturer.
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Answer:
In case the settlement is agreed ot the expected present value of the decision will be $600,000.
Now in the event of no settlement being made, there are 3 possibilities that could occur in case suing is done. These are given as:
It fails and looses 75,000 dollars, with a probability of 75,000 dollars= 0,5
She gets 2,000,000 if she wins case and is fully settled. Therefore in the case of thie the probability would be + 2,000,000 = 0,5 * 0.5 = 0,25
She gets a 500,000 case but not complete settlement. In this case, the probability is +500,000 = 0.5 * 0.5 = 0.25
The expected current value would therefore be given in this case as:
= 0.5 * (-75 thousand). + 0.25 * (2 thousands) + 0.25 * [500,000]
= - 37.500 + 500.000 + 125 thousand
= 587,500, $less than six hundred thousand dollars
Consequently, the fabricator should not sue and settlement is required.
