# Fin 419 week 2 assignment

Week 2 Text Assignments

5.3)      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:

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 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?

5.4)      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.

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 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?

P5-5) Risk and probability Micro-Pub, Inc., is considering the purchase of one of two microfilm cameras, R and S. Both should provide benefits over a 10-year period, and each requires an initial investment of \$4,000. Management has constructed the table (at the top of the facing page) of estimates of rates of return and probabilities for pessimistic, most likely, and optimistic results.

a. Determine the range for the rate of return for each of the two cameras.

b. Determine the expected value of return for each camera.

c. Purchase of which camera is riskier? Why? In Excel Please

10.4)    Basic sensitivity analysis Murdock Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table.

 Project A Project B Initial Investment \$8,000 \$8,000 Outcome Annual cash inflows Pessimistic \$200 \$900 Most Likely 1000 1000 Optimistic 1800 1100

a.         Determine the range of annual cash inflows for each of the two projects.

b.         Assume that the firm’ s cost of capital is 10% and that both projects have 20-year lives. Construct a table similar to this for the NPVs for each project. Include the range of NPVs for each project.

c.         Do parts a and b provide consistent views of the two projects? Explain.

d.         Which project do you recommend? Why?

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