You are considering investing in one of two projects, which have the following returns and probabilities of occurrence: Probability 0.10 0.20 0.25 0.30 0.10 0.05 Project A -20% 0 10% 15% 20% 40% Return on Investment Project B -35% -10% 15% 25% 40% 50% (c) If risk is not a concern which project would you prefer? (d) What is the probability that your preferred project (Problem c) is less profitable than the non-preferred one (For example if you chose projA in problem c, what is the probability that Proj.B is more profitable than Proj. A or vice versa)

You are considering investing in one of two projects, which have the following returns and probabilities of occurrence: Probability 0.10 0.20 0.25 0.30 0.10 0.05 Project A -20% 0 10% 15% 20% 40% Return on Investment Project B -35% -10% 15% 25% 40% 50% (c) If risk is not a concern which project would you prefer? (d) What is the probability that your preferred project (Problem c) is less profitable than the non-preferred one (For example if you chose projA in problem c, what is the probability that Proj.B is more profitable than Proj. A or vice versa)

Name: You are considering investing in one of two projects, which have the
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Description: You are considering investing in one of two projects, which have the following returns andprobabilities of occurrence:Probability0.100.200.250.300.100.05Project A-20%010%15%20%40%Return on InvestmentProject B-35%-10%15%25%40%50%(c) If risk is not a

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 2P

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Consider a decision maker who is comfortable with an investment decision that has a 50% chance of earning $25,000 and a 50% chance of losing $12,500, but not with any larger investments that have the same relative payoffs. Write the equation for the exponential function that approximates this decision maker’s utility function. Plot the exponential utility function for this decision maker for x values between –20,000 and 35,000. Is this decision maker risk-seeking, risk-neutral, or risk-averse? Suppose the decision maker decides that she would actually be willing to make an investment that has a 50% chance of earning $30,000 and a 50% chance of losing $15,000. Plot the exponential function that approximates this utility function and compare it to the utility function from part (b). Is the decision maker becoming more risk-seeking or more risk-averse?
The Ajax Company uses a portfolio approach to manage their research and development (RD) projects. Ajax wants to keep a mix of projects to balance the expected return and risk profiles of their RD activities. Consider a situation in which Ajax has six RD projects as characterized in the table. Each project is given an expected rate of return and a risk assessment, which is a value between 1 and 10, where 1 is the least risky and 10 is the most risky. Ajax would like to visualize their current RD projects to keep track of the overall risk and return of their RD portfolio. a. Create a bubble chart in which the expected rate of return is along the horizontal axis, the risk estimate is on the vertical axis, and the size of the bubbles represents the amount of capital invested. Format this chart for best presentation by adding axis labels and labeling each bubble with the project number. b. The efficient frontier of RD projects represents the set of projects that have the highest expected rate of return for a given level of risk. In other words, any project that has a smaller expected rate of return for an equivalent, or higher, risk estimate cannot be on the efficient frontier. From the bubble chart in part a, which projects appear to be located on the efficient frontier?
Start with the partial model in the file Ch10 P23 Build a Model.xlsx on the textbooks Web site. Gardial Fisheries is considering two mutually exclusive investments. The projects expected net cash flows are as follows: a. If each projects cost of capital is 12%, which project should be selected? If the cost of capital is 18%, what project is the proper choice? b. Construct NPV profiles for Projects A and B. c. What is each projects IRR? d. What is the crossover rate, and what is its significance? e. What is each projects MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of Project Bs life.) f. What is the regular payback period for these two projects? g. At a cost of capital of 12%, what is the discounted payback period for these two projects? h. What is the profitability index for each project if the cost of capital is 12%?
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Suppose an investor is concerned about a business choice in which there are three projects, the probability and returns are given below. Probability Return 0.4 $100 0.4 40 0.2 -30 The expected value of the uncertain investment is $ ----------- (round off to the nearest dollar
Suppose your firm is considering investing in a project with the cash flows shown below, that the required rate of return on projects of this risk class is 11 percent, and that the maximum allowable payback and discounted payback statistics for your company are 3.0 and 3.5 years, respectively. Time: 0 1 2 3 4 5 Cash flow: −$238,000 $66,100 $84,300 $141,300 $122,300 $81,500 Use the NPV decision rule to evaluate this project.