Problem 10.4 in Ch. 10

University of Phoenix

FIN 419 Finance for Decision Making

Problems 5.3, 5.4, and 5.13 in Ch. 5

Problem 10.4 in Ch. 10

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

Sharon would choose investment Y because only the expected returns matters to the company not the risk that is required.

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

Sharon would choose investment X because the expected returns must increase for the company if the risk goes up

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

Sharon would choose investment Z because to the company there is an acceptable decrease in return if the risk increases.

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

Financial managers would prefer investment X because it is a low risk, high return on the investment.

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

The range of the rates of return for Expansion A is 24% - 16% = 8% The range of the rates of return for Expansion B is 30% - 10% = 20%

b. Which project is less risky? Why?

Expansion A is less risky because they both offer the same most likely return but Expansion A return is with a lot less risk.

c. If you were making the investment decision, which one would you choose? Why?

I would also choose Expansion A because of the risk involved. I am about making money and since the likely return is the same, why go through more hassle to get there.

What does this imply about your feelings toward risk?

This implies that I will only take the necessary risks that I would have to take to get the best returns on investments.

d. Assume that expansion B’s most likely outcome is 21% per year and that all other facts remain the same. Does this change your answer to part c? Why?

No this does not change my answer to part C because that is only a 1% increase and 20% risk is still not worth the 1% increase in return. The risk is still to high for me.

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a. Calculate the expected portfolio return, rp, for each of the 6 years.

|Expected portfolio returns | | |Expected Return | | | | |Year |Stock L |Stock M |Rp Return Calculations | |Expected Rp | |2010 |14% |20% |(.4 x .14) + (.6 x .2) |= |18% | |2011 |14% |18% |(.4 x .14) + (.6 x .18) |= |16% | |2012 |16% |16% |(.4 x .16) + (.6 x .16) |= |16% | |2013 |17% |14% |(.4 x .17) + (.6 x .14) |= |15% | |2014 |17% |12% |(.4 x .17) + (.6 x .12) |= |14% | |2015 |19% |10% |(.4 x .19) + (.6 x .1) |= |14% | | | | | | | |

b. Calculate the expected value of portfolio returns, , over the 6-year period. _

rp = 18% + 16% + 16% + 15% + 15% + 14% + 14% = 93% = 15%

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c. Calculate the standard deviation of expected portfolio returns, rp, over the 6-year period....

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