Principles of Managerial Finance

LG2

LG2

252 PART 2 Important Financial Concepts

a. Which project is least risky, judging on the basis of range?

b. Which project has the lowest standard deviation? Explain why standard devi-

ation is not an appropriate measure of risk for purposes of this comparison.

c. Calculate the coefficient of variation for each project. Which project will

Greengage’s owners choose? Explain why this may be the best measure of

risk for comparing this set of opportunities.

5–9 Assessing return and risk Swift Manufacturing must choose between two asset

purchases. The annual rate of return and the related probabilities given in the

following table summarize the firm’s analysis to this point.

a. For each project, compute:

(1) The range of possible rates of return.

(2) The expected value of return.

(3) The standard deviation of the returns.

(4) The coefficient of variation of the returns.

b. Construct a bar chart of each distribution of rates of return.

c. Which project would you consider less risky? Why?

5–10 Integrative—Expected return, standard deviation, and coefficient of variation

Three assets—F, G, and H—are currently being considered by Perth Industries.

The probability distributions of expected returns for these assets are shown in

the following table.

a. Calculate the expected value of return, k

• ,for each of the three assets. Which
  provides the largest expected return?

Asset F Asset G Asset H

jPrj Return, kj Prj Return, kj Prj Return, kj

1 .10 40% .40 35% .10 40%

2 .20 10 .30 10 .20 20

3 .40 0 .30  20 .40 10

4.20 5.200

5.10 10 .10  20

Project 257 Project 432

Rate of return Probability Rate of return Probability

10% .01 10% .05

10 .04 15 .10

20 .05 20 .10

30 .10 25 .15

40 .15 30 .20

45 .30 35 .15

50 .15 40 .10

60 .10 45 .10

70 .05 50 .05

80 .04

100 .01