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This question requires the calculation of the expected value of choosing Compensation Plan 1 and the expected value of choosing Compensation Plan 2, and then selecting the plan with the higher expected value. The expected value of each compensation plan is a weighted average of the possible contribution margins that would result under it, using the probabilities of the sales results as the weights. The contribution margin is total revenue minus total variable expenses. Regardless of which compensation plan is chosen, there is a 60% probability that sales will be good. Since sales will be either good or excellent, then there must be a 40% probability (100% ? 60%) that sales will be excellent. Under Plan 1, the contribution margin will be $300,000 if sales are excellent (40% probability) and $240,000 if sales are good (60% probability). So the expected value of choosing Plan 1 is ($300,000 × .40) + ($240,000 × .60), which is $264,000. Under Plan 2, the contribution margin will be $370,000 if sales are excellent (40% probability) and $180,000 if sales are good (60% probability). So the expected value of choosing Plan 2 is ($370,000 × .40) + ($180,000 × .60), or $256,000. The expected value of Plan 1, $264,000, is $8,000 greater than the expected value of Plan 2, $256,000, so Plan 1 should be adopted.
The plan that should be adopted is the one with the higher expected value.
The plan that should be adopted is the one with the higher expected value.
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