. The following payoff table summarizes gross profits (before compensation), arising from two different levels of effort and factors outside of the manager’s control(stage of the business cycle and resulting sales).
Recession Probability = 0.5 Expansion Probability = 0.5
Low effort $75,000 $200,000
High effort $150,000 $400,000
Assume that the disutility of “high” effort is 50 for the manager and that he or she is risk averse so that Utility = (Compensation)0.5.
A. What is the expected gross profit of the firm after compensation is the manager is paid a flat salary of $40,000? (4 POINTS)
B. What bonus (percentage of gross profit) should be paid to the manager in lieu of this flat salary in order to maximize gross profit to the corporation aftercompensation? (3 POINTS)
C. What is the dollar amount of expected gross profit after the appropriate compensation bonus is paid to the manager? (3 POINTS)