Assignment:
Economics of Risk and Uncertainty Applied Problems
Please complete the following two applied problems. Show all your calculations and explain your results.
Problem 1:
A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump sum of $12 million in Year 0 (the current year), or in parts, in which $7 million can be provided at the end of Year 1, and another $7 million can be provided at the end of Year 2.
Describe your answer for each item below in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:
a. Assuming the opportunity interest rate is 8%, what is the present value of the second alternative mentioned above? Which of the two alternatives should be chosen and why?
b. How would your decision change if the opportunity interest rate is 12%?
c. Provide a description of a scenario where this kind of decision between two types of payment streams applies in the "real-world" business setting.
Problem 2:
The San Diego LLC is considering a three-year project, Project A, involving an initial investment of $80 million and the following cash inflows and probabilities
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Year 0
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Year 1
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Year 2
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Year 3
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Probability
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Cash Flow
($ mil.)
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Probability
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Cash Flow
($mil.)
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Probability
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Cash Flow
($ mil.)
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0.2
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50
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0.1
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60
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0.3
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70
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0.3
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40
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0.2
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50
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0.4
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60
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0.4
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30
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0.3
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40
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0.1
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50
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0.1
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20
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0.4
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30
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0.2
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40
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Initial Investment
$80 mil.
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|
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|
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Discount Rate
8%
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|
|
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Describe your answer for each question in complete sentences, whenever it is necessary. Show all of your calculations and processes for the following points:
a. Describe and calculate Project A's expected net present value (ENPV) and standard deviation (SD), assuming the discount rate (or risk-free interest rate) to be 8%. What is the decision rule in terms of ENPV? What will be San Diego LLC's decision regarding this project? Describe your answer.
b. The company is also considering another three-year project, Project B, which has an ENPV of $32 million and standard deviation of $10.5 million. Project A and B are mutually exclusive. Which of the two projects would you prefer if you do not consider the risk factor? Explain.
c. Describe the coefficient of variation (CV) and the standard deviation (SD) in connection with risk attitudes and decision making. If you now also consider your risk-aversion attitude, as the CEO of the San Diego LLC will you make a different decision between Project A and Project B? Why or why not?
Required Resources
Text
Please read the following chapters in: Managerial Economics:
• Chapter: Foundations of Managerial Economics
• Chapter: Decision Making Under Risk and Uncertain
Article
Field, A (2013). Jessica Alba's Triple Bottom startup raises $25 million Forbes.
Scott, R. (2012). Forbes.
Websites
- Bloomberg
- Cable News Network
- The Economist
Discussion 1 Firm Objectives
Read the articles Jessica Alba's Triple Bottom startup raises $25 million and The bottom line of corporate good.
In reference to the articles, discuss how firms incorporate the triple bottom line concept into traditional business concerns over profitability. Respond to at least two of your classmates' posts.
Guided Response: In 300 words or more, please, provide your response to the above discussion question. Comment on how customers can influence firms to pay more attention to the preservation of the natural environment. Respond substantively to at least two of your classmates' postings. Substantive responses use theory, research, and experience or examples to support ideas and further the class knowledge on the discussion topic.
Discussion 2 Decision Making Under Uncertainty
To save on gasoline expenses, Edith and Mathew agreed to carpool together for traveling to and from work. Edith preferred to travel on I-20 highway as it was usually the fastest, taking 25 minutes in the absence of traffic delays. Mathew pointed out that traffic jams on the highway can lead to long delays making the trip 45 minutes. He preferred to travel along Shea Boulevard, which was longer (35 minutes), but rarely had traffic jams. Edith agreed that in case of traffic jams, Shea Boulevard was a reasonable alternative. Neither of them knows the state of the highway ahead of time. After driving to work on the I-20 highway for 1 month (20 workdays), they found the highway to be jammed 3 times. Assuming that this month is a good representation of all months ahead, should Edith and Mathew continue to use the highway for traveling to work?
How would you conclusion change for the winter months, if bad weather makes it likely for traffic jams on the highway to increase to 6 days per month?
How would your conclusion change if Mathew purchased a new smart-phone app that could show the status of the highway traffic prior to their drive each morning, thus reducing the probability of them getting into a jam down to only 1 day per month (where on this day, the app showed no traffic jam, but a jam developed in the meantime as they were driving along the highway).
Guided Response: In 300 words or more, please, provide your response to the above discussion question. Please, show all your calculations and explain your answers. Further, comment on how the conclusions of this problem will change if there was no uncertainty and the highway always had traffic jams, whereas Shea Blvd was always traffic jam free? Is this scenario realistic and why? Respond substantively to at least two of your classmates' postings.