1. You have mineral rights a piece of land that you believe may have oil underground.

There is
only a 10% chance that you will strike oil if you drill, but the payoff is $200,000. It costs
$10,000 to drill. The alternative is not to drill at all, in which case your profit is zero. Before
you drill you might consult a geologist who can assess the promise of the piece of land. She
can tell you whether your prospects are "good" or "poor." But she is not a perfect predictor.
If there is oil, the conditional probability is 0.95 that she will say prospects are good. If no-
oil, the conditional probability is 0. 85 that she will say poor. Draw a decision tree that
includes the "Consult Geologist" alternative. Be careful to calculate the appropriate
probabilities to include in the decision tree. Finally, calculate the EVII for this geologist. If
she charges $7000, what should you do?

2. Suppose you are considering two investment options: Option A and Option B. Option A has
a 70% chance of giving a 10% return and a 30% chance of giving a 5% return. Option B has a
50% chance of giving a 15% return and a 50% chance of giving a 0% return. Your utility
function is U(x) = sqrt(x), where x is the return on the investment. What option should you
choose?

3. Suppose the time between consecutive arrivals at a store follows an exponential

distribution with a mean of 5 minutes. What is the probability that the next arrival will occur
within the next 2 minutes?

4. Suppose that the number of defects in a production process follows a Poisson distribution
with a mean of 2 defects per hour. What is the probability that there are more than 4
defects in a 2-hour period?

5. Suppose you are waiting for a bus that arrives every 10 minutes on average, and the waiting
time follows an exponential distribution. You have already waited for 5 minutes. What is the
probability that you will have to wait for more than 10 minutes in total?

6. Suppose a call center receives an average of 10 customer calls per hour, and the number of
calls the call center receives in an hour is Poisson distributed. What is the probability of
receiving exactly 12 calls in an hour?

7. Suppose that a call center receives an average of 2 customer calls per minute, and the
number of calls received per minute follows a Poisson distribution. There are 3 customer
service representatives available to take calls, and each representative can handle at most 1
call per minute. What is the probability that a call is not handled immediately?

8. Suppose that the probability that a basketball player makes his free-throw is 80%. If the
player takes 10 free-throw shots, what is the probability that the player makes exactly 8 of
them?
9. Suppose that a company produces computer chips, and 10% of the chips are defective. The
company ships a batch of 500 chips to a customer. If the customer tests 50 randomly
selected chips from the batch, what is the expected number of defective chips found?

10. A decision maker's assessed risk tolerance is $1210. Assume that this individual's
preferences can be modeled with an exponential utility function.
 Find U($1000), U($800), U($0), and U(-$1250).
 Find the expected utility for an investment that has the following payoff distribution:
P($1000) = 0.33
P($800) = 0.21
P($0) = 0.33
P(-$1250) = 0.13
 Find the exact certainty equivalent for the investment and the risk premium.
 Find the approximate certainty equivalent using the expected value and variance