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P5–3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Currently, the firm earns 12% on its investments, which have a risk index of 6%. The expected return and expected risk of the investments are as follows:

Investment Expected return Expected risk index
X 14% 7%
Y 12 8
Z 10 9

a. If Sharon were risk-indifferent, which investments would she select? Explain why.

If Sharon were risk-indifferent, the investments that she would select would be X. The Risk – indifferent manager does not change. There is no change in return would be required for increase in risk.

b. If she were risk-averse, which investments would she select? Why?

If she was a risk-averse, the investments that she would select would be X. The required return increases for an increase risk. The managers of risk-averse require a higher expected return to compensate them for taking greater risk.

c. If she were risk-seeking, which investments would she select? Why?

If she was a risk-seeking manager, she would choose Z. Z has a high expected risk and a low expected return. A risk-seeking manager requires return decrease for an increase in risk. This would not be good for the firm.

d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?

The traditional risk preference behavior exhibited by financial managers the investments that would be preferred would be that of a risk-averse do the fact that has a higher return and a lower risk.

P5–4 Risk analysis Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates shown in the following table:

a. Determine the range of the rates of return for each of the two projects.

The ranges of the rates of return for each of the two...
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