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Case Problem 2 Lawsuit Defense Strategy

Allied should counteroffer John $400,000 to settle a lawsuit, as this strategy has an expected value of $670,000 according to a decision tree analysis. If John accepts, the case is settled. If not, Allied must prepare for trial. If John counteroffers $600,000, Allied should accept. The risk profile shows probabilities of different settlement amounts ranging from $0 to $1,500,000.

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540 views3 pages

Case Problem 2 Lawsuit Defense Strategy

Allied should counteroffer John $400,000 to settle a lawsuit, as this strategy has an expected value of $670,000 according to a decision tree analysis. If John accepts, the case is settled. If not, Allied must prepare for trial. If John counteroffers $600,000, Allied should accept. The risk profile shows probabilities of different settlement amounts ranging from $0 to $1,500,000.

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Something Chic
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Case Problem 2: Lawsuit Defense Strategy

1. Decision Tree
Allied Accepts John's
Offer of $750,000
$750
John Accepts
Allied's Counteroffer
$400
0.10

Allied Loses
Damages of $1,500,000
$1500
0.3
1
Allied Counteroffers John Rejects Allied's Allied Loses Damages
with $400,000 Counteroffer of $750,000
2 3 $750
0.4 0.5

Allied Wins
No Damages
$0
0.2

Allied Accepts
John's Counteroffer
$600
John Counteroffers Allied Loses
with $600,000 Damages of $1,500,000
4 $1500
0.5 0.3

Allied Rejects Allied Loses Damages


John's Counteroffer of $750,000
5 $750
0.5

Allied Wins
No Damages
$0
0.20

To find the optimal decision strategy, we must fold the tree back computing expected values at the chance
nodes and choosing the least cost alternative at the decision nodes. Shown below are the values computed
at each node.

Node Value

1 670
2 670
3 825
4 600
5 825
Chapter 13

Shown below is the decision tree with all nonoptimal branches eliminated.
John Accepts
Allied's Counteroffer
$400
0.10

Allied Loses
Damages of $1,500,000
$1500
0.3
1
Allied Counteroffers John Rejects Allied's Allied Loses Damages
with $400,000 Counteroffer of $750,000
2 3 $750
0.4 0.5

Allied Wins
No Damages
$0
0.2

Allied Accepts
John's Counteroffer
$600
John Counteroffers
with $600,000
4
0.5

2. Allied should not accept John's offer to settle for $750,000. The strategy associated with a
counteroffer of $400,000 has an expected value of $670,000.

3. If John accepts Allied's counteroffer of $400,000, no further action is required. If John rejects
Allied's counteroffer and elects to have a jury decide the settlement amount, Allied must prepare for a
trial. If John counteroffers with $600,000, Allied should accept John's counteroffer.

4. To develop the risk profile for the optimal strategy, we simply multiple the branch probabilities on all
paths to the end points of the decision tree. The risk profile is given below in tabular form.

Settlement Amount
($1000s) Probability

0 0.08

400 0.10

600 0.50

750 0.20
1500 0.12

1.00

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