Bhimani, Horngren, Datar and Rajan,
Management and Cost Accounting, 5
th
Edition, Instructor’s Manual
© Pearson Education Limited 2012
3 The expected operating income from the two products would be identical. If the choice criterion is to maximise expected operating income, the company will be indifferent between emerald green and shocking pink umbrellas. However, assume that the management considers risk factors. Emerald green umbrellas, for example, have a 10% chance of selling only 100,000 units, which would result in a net operating loss of €200,000. Also, there is a 30% chance that sales of emerald green will exceed 300,000 units.
If this event happens, the operating income of emerald green umbrellas will be higher than the operating income of shocking pink umbrellas. The expected values are important, but the dispersion of the probability distribution is also important. Normally,
the wider the dispersion, the greater the risk. Knowledge of the entire probability distribution helps management assess the risk before reaching a decision.
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