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P5-3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z.
P5–3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation,wishes to evaluate three prospective investments: X, Y, and Z. Currently, thefirm earns 12% on its investments, which have a risk index of 6%. The expectedreturn and expected risk of the investments are as follows: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?P5–4 Risk analysis Solar Designs is considering an investment in an expandedproduct line. Two possible types of expansion are being considered. After investigatingthe possible outcomes, the company made the estimates shown in thefollowing table: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 allother facts remain the same. Does this change your answer to part c? Why?P5–13 Portfolio analysis You have been given the return data shown in the first tableon three assets—F, G, and H—over the period 2007–2010.Using these assets, you have isolated the three investment alternatives shown inthe following table:a. Calculate the expected return over the 4-year period for each of the threealternatives.b. Calculate the standard deviation of returns over the 4-year period for eachof the three alternatives.c. Use your findings in parts a and b to calculate the coefficient of variation foreach of the three alternatives.d. On the basis of your findings, which of the three investment alternatives doyou recommend? Why?
