Internal Rate of Return

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part one


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. b. If she were risk-averse, which investments would she select? Why? c. If she were risk-seeking, which investments would she select? Why? d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?


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. b. Which project is less risky? Why?
c. If you were making the investment decision, which one would you choose? Why? What does this imply about your feelings toward risk? d. Assume that...
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