Finance 419 Assignment for Week Two Individual Assignment.

Topics: Investment, Rate of return, Management Pages: 9 (1999 words) Published: January 19, 2011
Finance 419 assignmentfor week two individual assignment.

Assignments from the Readings
FIN/419

Assignments from the Readings
Ch. 5: P5–3, P5–4, P5–13
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 returnExpected risk index
X14%7%
Y 12 8
Z 109

a. If Sharon were risk-indifferent, which investments would she selectExplain why.
Sharon would select X because the risk-indifferent manager’s attitude is no change in return would be required for the increase in risk and because the return is currently at 12% with a 6% index (half), X is the same amount of risk and return (half).

b. If she were risk-averse, which investments would she select? Why?
Because the risk-averse manager requires higher expected returns to compensate him or her for taking greater risk, Sharon would select X again because the return is two times greater than the risk in X.

c. If she were risk-seeking, which investments would she select? Why?
Because the risk-seeking manager is willing to give up some return to take more risk, Sharon would select Z because this risk is almost equal to the return.

d. Given the traditional risk preference behavior exhibited by financial managers,
which investment would be preferred? Why?
Given the traditional risk preference behavior exhibited by financial managers, X would be the preferred investment because the return on investment is two times greater than the risk and per Gitman (2009) “most manager are risk-averse.”

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:
Expansion A Expansion B
Initial investment $12,000 $12,000
Annual rate of return
Pessimistic 16% 10%
Most likely 20% 20%
Optimistic 24% 30%

a. Determine the range of the rates of return for each of the two projects. The range is found by subtracting the
return associated with the pessimistic outcome from the return associated with
the optimistic outcome: Expansion A- 24%-16%=8%; Expansion B- 30%-10%=20%

b. Which project is less risky? Why?
Expansion A is less risky because Expansion A’s range is only 8% compared to Expansion B’s 20%,.

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