# Question 66: The Settlement Offer and the Decision Tree

## Your role

You represent Emberline Systems, the defendant in a contract case. Trial is four months away. The plaintiff's current settlement offer expires in three days, and the chief financial officer wants a settle-or-litigate recommendation based only on the supplied probabilities and costs.

## Governing law

Use the following decision rules for this assignment:

1. Expected monetary cost is the sum of each possible outcome multiplied by its supplied probability, plus future legal and transaction costs attributable to that course.

2. Probabilities in a branch must total 100 percent. Do not replace the supplied probabilities with intuitive estimates.

3. Costs already incurred are sunk and do not affect the choice among current alternatives.

4. A future litigation cost is counted whenever the branch requiring that work occurs, regardless of who ultimately wins, unless the facts state otherwise.

5. A settlement amount and the transaction cost required to complete it are both counted in the settlement branch.

6. If a counteroffer is rejected and the current offer will no longer be available, the rejected branch proceeds to trial on the supplied trial economics.

7. Expected value is not a prediction that the average result will occur. Tail exposure and cash timing may be stated separately, but they may not replace the expected-cost calculation.

8. Recommend the course with the lowest expected cost unless a supplied nonmonetary constraint changes the decision. No such constraint is supplied here.

## Facts

Emberline has already spent $300,000 defending the case. That amount cannot be recovered and is the same under every current choice.

If the case proceeds directly to trial, future defense cost will be $550,000. Counsel supplies the following mutually exclusive trial outcomes:

* 30 percent probability of a complete defense verdict and no payment to plaintiff.
* 50 percent probability of a $1,600,000 judgment.
* 20 percent probability of a $4,500,000 judgment.

There is no fee shifting, insurance, interest, appeal, or collection discount in this assignment.

The plaintiff offers a complete release for $1,450,000. Completing the settlement will cost Emberline an additional $50,000 in legal, accounting, and closing work.

Emberline may instead counter at $1,200,000. The supplied probability of acceptance is 45 percent. Negotiating and documenting the counter costs $40,000 whether it is accepted or rejected. If accepted, no other settlement transaction cost applies. If rejected:

* The current $1,450,000 offer is withdrawn.
* The case proceeds to the same trial outcomes.
* Future defense cost rises from $550,000 to $625,000 because expert and trial deadlines will then be compressed.

Management argues that a 30 percent defense-verdict chance means paying anything above $1 million is irrational. Counsel has not identified any operational, reputational, insurance, or precedent effect outside the supplied monetary record.

## Assignment

Analyze:

* Expected judgment if the case proceeds to trial.
* Total expected cost of proceeding directly to trial.
* Total cost of accepting the current settlement.
* Expected cost of making the $1,200,000 counteroffer, showing accepted and rejected branches.
* The treatment of the $300,000 already spent.
* The significance of the $4,500,000 tail outcome.
* Why the defense-verdict probability does or does not determine the decision.
* The concrete recommendation before the three-day deadline.

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