Response to the following problem:
Here are the estimated ROE distributions for Firms A, B, and C:
|
|
|
PROBABILITY
|
|
|
|
|
0.1
|
0.2
|
0.4
|
0.2
|
0.1
|
|
Firm A: ROEA
|
0.0%
|
5.0%
|
10.0%
|
15.0%
|
20.0%
|
|
Firm B: ROEB
|
(2.0)
|
5.0
|
12.0
|
19.0
|
26.0
|
|
Firm C: ROEC
|
(5.0)
|
5.0
|
15.0
|
25.0
|
35.0
|
a. Calculate the expected value and standard deviation for Firm C's ROE. ROEA 10.0%, A 5.5%; ROEB 12.0%, B 7.7%.
b. Discuss the relative riskiness of the three firms' returns. (Assume that these distributions are expected to remain constant over time.)
c. Now suppose all three firms have the same standard deviation of basic earning power (EBIT/Total assets), A B C 5.5%. What can we tell about the financial risk of each firm?