Investment A Investment B
Income Probability Income Probability
4000 0.2 4000 0.3
5000 0.3 6000 0.4
6000 0.3 8000 0.3
(a) Using Excel’s statistical tools, calculate the standard deviation of the distribution of each investment. (b) Which of the two investments is more risky? (c) Which investment should the individual choose?
NOTE: Use table 14-4 as reference
Conditions: Poor Good Excellent
Probability: 40% 50% 10%
(a) Using Excel, calculate the expected value of each project and identify the preferred project according to this criterion. (b) Assume that the individual’s utility function for profit is U(X) = X – 0.05X2. Calculate the expected utility of each project and identify the preferred project according to this criterion. (c) Is this individual risk averse, risk neutral, or risk seeking? Why?
NOTE: Use tables 14-5 and 14-6 as reference
Employee Value Probability
What is the expected value of five employees you hire?
NOTE: Need to consider adverse selection.
NOTE: Remember the firm has a limited capital budget of $2.4 million for the coming year. In other words, the firm faces the capital rationing and should use the profitability index as its investment criterion (pp. 637–640).
tax income to the holders of the company’s 100 million shares of common stock. A share of the common stock of the company currently sells for eight times current dividends.
Management and outside analysts expect the growth rate of earnings and dividends for the company to be 7.5 percent per year. Calculate the cost of equity capital to this fi rm.
NOTE: Use the dividend valuation model (pp. 642–643). “A share of the common stock of the company currently sells for eight times current dividends“
NOTE: Change the present value coefficient from 1/(1+0.5)n to 1/(1+0.05)n. That is the discount rate of 5% instead of 50%