Question 1. Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given below:
Possible Sales
Market Reaction in Units Probabilities
Low response . . . . . . . . . . . . . 20 .10
Moderate response . . . . . . . . . 40 .30
High response . . . . . . . . . . . . . 55 .40
Very high response . . . . . . . . . 70 .20
a. What is the expected value of unit sales for the new product?
b. What is the standard deviation of unit sales?
Question 2: Possible outcomes for three investment alternatives and their probabilities of occurrence are given below.
Alternative 1 Alternative 2 Alternative 3
Outcomes Probability Outcomes Probability Outcomes Probability
Failure . . . . . . . . 50 .2 90 .3 80 .4
Acceptable . . . . . 80 .4 160 .5 200 .5
Successful . . . . . 120 .4 200 .2 400 .1
Rank the three alternatives in terms of risk (compute the coefficient of variation).
Question 3: Silverado Mining Company is analyzing the purchase of two silver mines. Only one investment will be made. The Alaska mine will cost $2,000,000 and will produce $400,000 per year in years 5 through 15 and $800,000 per year in years 16 through 25. The Montana mine will cost $2,400,000 and will produce $300,000 per year for the next 25 years. The cost of capital is 10 percent.
a. Which investment should be made? (Note: In looking up present value factors for this problem, you need to work with the concept of a deferred annuity for the Alaska mine. The returns in years 5 through 15 actually represent 11 years; the returns in years 16 through 25 represent 10 years.)
b. If the Alaska mine justifies an extra 5 percent premium over the normal cost of capital because of its riskiness and relative uncertainty of flows, does the investment decision change?