LG2LG2250 PART 2 Important Financial Concepts
the possible outcomes, the company made the estimates shown in the following
tablea. Determine the rangeof 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 partc?
Why?5–5 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 con-
structed the following table of estimates of rates of return and probabilities for
pessimistic, most likely, and optimistic results:a. Determine the rangefor the rate of return for each of the two cameras.
b. Determine the expected valueof return for each camera.
c. Purchase of which camera is riskier? Why?5–6 Bar charts and risk Swan’s Sportswear is considering bringing out a line of
designer jeans. Currently, it is negotiating with two different well-known design-
ers. Because of the highly competitive nature of the industry, the two lines of
jeans have been given code names. After market research, the firm has estab-
lished the expectations shown in the following table about the annual rates
of returnCamera R Camera S
Amount Probability Amount ProbabilityInitial investment $4,000 1.00 $4,000 1.00
Annual rate of return
Pessimistic 20% .25 15% .20
Most likely 25% .50 25% .55
Optimistic 30% .25 35% .25Expansion A Expansion BInitial investment $12,000 $12,000
Annual rate of return
Pessimistic 16% 10%
Most likely 20% 20%
Optimistic 24% 30%