Risk and Return and Cost of Capital Problems

P8-1

a)
Expected Rate of Return

$
$
$

Y
55,000
6,800
55,000

X

Previous Market Value
Cash Flow
Current Market Value

X
20,000 $
1,500 $
21,000 $

Y

12.50%

12.36%

X:

rt = (Ct + P rt = ($1,50 rt = 0.125 =

b)
Both investments are equally risky. Keel should recommend Investment X because it has a

Pt - Pt-1) / (Pt-1)

Y:

rt = (Ct + Pt - Pt-1) / (Pt-1)

0 + $21,000 - $20,000) / ($20,000)

rt = ($6,800 + $55,000 - $55,000) / ($55,00

= 12.5%

rt = 0.124 = 12.4%

a higher rate of return for the same level of risk.

00)

P8-4

Initial Investment
Annual Rate of Return
Pessimistic
Most Likely
Optimistic
a)
Range

Expansion A Expansion B
12000
12000
16%
20%
24%

10%
20%
30%

Expansion A Expansion B
8%
20%

Range of A: 24% - 16
Range of B: 30% - 10

b)

Expansion A is less risky because the range for Expansion A is substantially lower than the rang

c)

I'm a risk-averse decision maker. I would prefer Expansion A over Expansion B because Expansi
Expansion A and Expansion B both have most likely return of 20% and an initial investment of $

d)

No, this does not change my answer.
I am still a risk-averse decision maker, and the 1% increase in the most likely rate of return for
The risk for Expansion B is still high and I am not willing to increase my risk by 12% (20% - 8% =

6% = 8%
0% = 20% ge for Expansion of B. ion A appears to be less risky.
$12,000, so if I were to choose an investment, it would be Expansion A because I am taking less risk fo

Expansion B won't make me change my answer.
= 12%) in order to gain 1%.

or the same return as Expansion B.

P8-14
Year
2013
2014
2015
2016
a)

Expected Return
Asset F
Asset G
Asset H
16%
17%
14%
17%
16%
15%
18%
15%
16%
19%
14%
17%

Alternative

Expected
Return

1

17.50%

2
3

Alternative
1
2
3

16.50%

Alternative 1:

16.50%
Alternative 2:

Alternative 3: