[Biff-1955-Tannen]

Curious as to why the explanation is only using the 60% chance of a win into the equation and completely ignoring the fact that there is a 40% chance you will not win and have to pay the $12,000 retainer… For expected value, shouldn’t we be factoring this in? Is the retainer not paid if we lose or what?

A vendor offered Wyatt Co. $25,000 compensation for losses resulting from faulty raw materials. Alter­nately, a lawyer offered to represent Wyatt in a lawsuit against the vendor for a $12,000 retainer and 50% of any award over $35,000. Possible court awards with their associated probabilities are as follows:

Award Probability

---

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$75,000 0.6

0 0.4

Compared to accepting the vendor’s offer, the expected value for Wyatt to litigate the matter to verdict provides a:

Here there are two possible outcomes: collecting $25,000, or accepting the lawyer’s offer to represent Wyatt in the lawsuit. We will need to compare the expected value of $25,000 (fixed at $25,000) with the expected value if the lawsuit alternative is chosen.

If the lawsuit is chosen, Wyatt will lose the $12,000 retainer, but have a 60% probability of winning $75,000 less the lawyer’s contingent fee of 50% of the award above $35,000. The contingent fee would be 50% times ($75,000 − $35,000) which is 0.50 × $40,000, or $20,000.

The value of winning the lawsuit is $75,000 less the contingent fee of $20,000, or $55,000. The expected value of winning the lawsuit is the probability of winning (60%) multiplied by the value of winning ($55,000), or $33,000. However, Wyatt will have to pay the retainer of $12,000, leaving a net expected value of $21,000.

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[tuanxn]

The answer is $21,000 but the solution arrives at the figure incorrectly.

If we win the case, we receive $75,000 – $20,000 (50% fee) – $12,000 (retainer) = $43,000
If we lose the case, we receive $0 – $12,000 (retainer) = ($12,000)

60% chance of winning $43,000 = $25,800
40% chance of losing $12,000 = ($4,800)

Expected value is $25,800 – $4,800 = $21,000

[Biff-1955-Tannen]

Thank you very much for clearing that up. I thought that was odd.

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[tuanxn]

Yeah, what are the chances of arriving at the same answer lol

[Author]

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