A manager must decide which one of three projects should be implemented. For each project the possible outcomes and their associated probabilities…

The scenario describes decision-making under risk, as the probabilities of the various outcomes are known and can be estimated reliably. The manager's decision criterion is based solely on the highest expected value (EV) of profit. This approach defines a risk-neutral attitude. A risk-neutral decision-maker is indifferent to the level of risk (i.e., the variability of outcomes) and focuses only on the probability-weighted average. Consequently, measures of risk dispersion, such as the range of possible outcomes or the standard deviation, are irrelevant to their decision-making process.

A. A risk-averse manager would consider the standard deviation to select a less volatile project, but this manager is risk-neutral.

C. The situation involves risk (known probabilities), not uncertainty. The manager's focus on EV indicates a risk-neutral, not risk-seeking, attitude.

D. Selecting the highest possible outcome is a maximax strategy used under uncertainty, not the EV criterion being applied here.

1. Drury

C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning. In Chapter 11

"Decision-making under conditions of risk and uncertainty

" it is explained that a risk-neutral decision-maker uses the expected value criterion and is "indifferent to the dispersion of the possible outcomes" (p. 311). The chapter also distinguishes risk (where probabilities are known) from uncertainty (where they are not).

2. Bhimani

A.

Horngren

C. T.

Datar

S. M.

& Rajan

M. V. (2019). Management and Cost Accounting (7th ed.). Pearson. Chapter 21

"Decision making under uncertainty

" clarifies that when probabilities can be assigned to future outcomes

the situation is one of risk. It further states that using expected value as the decision rule assumes the decision-maker is risk-neutral (Section: "Expected value").

3. CIMA (2019). CIMA P2 Advanced Management Accounting Syllabus. The Chartered Institute of Management Accountants. Section C

"Managing costs of creating value

" subsection 2(c) "Dealing with risk and uncertainty in decision-making

" requires candidates to be able to "apply techniques for decision-making under conditions of risk and uncertainty

" which includes the application of expected values and understanding different risk attitudes. A risk-neutral approach is defined by the singular use of expected value.