P5-4 Risk analysis Solar Designs is considering an investment in an ex

QUESTION

P5-4 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 Bs most likely outcome is 21% per year and
that all other facts remain the same. Does this change your answer to
part c? Why?
Solution: a. Assuming optimistic , the ranges for project A =16-24% = 8 and Range for project B = 10-30% = 20 (Range = optimistic “ pessimistic) b. Project A is less risky, because the standard deviation = (optimistic “ pessimistic) / 6 Therefore, S.D. for A =( 24 “ 16 )/ 6 = 1.33% and S.D. for B = 30-10 / 6 = 3.33% c. I would choose A. because it has higher returns¦

n the upside, better returns on the downside, it has almost same returns with same investment level. Also, its standard deviation is less. d. No, it does not. As most likely part is similar and else all the other aspects are better for project A.

ANSWER:

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