Financial Risk and Return Considerations

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1. [Financial Risk and Return Considerations] Explain how you would choose between the following situations. Develop your answers from the perspective of the principles of entrepreneurial finance presented earlier in the chapter. You may arrive at your answers with or without making actual calculations.

A. You have $1,000 to invest for one year (this would be a luxury for most entrepreneurs). You can earn a 4% interest rate for one year at the Third First bank or a 5% interest rate at the First Fourth bank. Which savings account investment would you choose and why?

Third First bank: $1,000 x 1.04 = $1,040 First Fourth bank: $1,000 x 1.05 = $1,050

The First Fourth bank loan would be preferred because
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An outside venture investor is considering investing $100,000 in either your new venture or in another venture, or invest $50,000 in each venture. At the end of one year, the value of the venture might be either $0 or $1,000,000. The other venture is expected to be worth either $50,000 or $500,000 at the end of one year. Which investment choice (yours, the other venture, or half-and-half) do you think the venture investor would choose to invest in? Why? Low Result High Result Expected Value Your venture: $0 $1,000,000 ($0 + $1,000,000)/2 = $500,000
Other venture: $50,000 $500,000 ($50,000 + $500,000)/2 = $275,000 Half-and-half: $25,000 $750,000 ($25,000 + $750,000)/2 = $387,500

Under the half-and-half alternative, $50,000 is invested in each venture. The low result outcome is $25,000 ($0 + $25,000) and the high result outcome is $750,000 ($250,000 + $500,000). In actuality there are two more possible outcomes under the half-and-half alternative. They are: $250,000 ($0 + $250,000) and $525,000 ($25,000 + $500,000). Thus, the more complete half-and-half calculation would be: ($25,000 + $250,000 + $525,000 + $750,000)/4 = $387,500. A venture investor who is not very risk averse might choose your venture to invest in since there is a possibility of receiving $1,000,000 in return for putting up $100,000. Of course, such an investor could lose all of his/her investment if the low result occurs. A more risk averse venture
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