Question: You are the owner of a firm considering two expansion options. Option A has an expected net present value of $100,000 and a standard deviation of $20,000. Option B has an expected net present value of $110,000 and a standard deviation of $80,000. Your estimated probability distributions of the two options are as shown below.
a. The firm you own is a small one. This project would strain your resources, and the firm might struggle for some time if returns from the project turned out to be poor. Given that background, which of the two expansion options would you choose? Explain.
b. Before you can undertake that expansion, you have sold your firm to a much larger corporation, so your firm becomes a small division of that corporation. You manage that division. Now your expansion is only a small project among many investments that the large corporation is undertaking. You decide that the profitability of your expansion would be uncorrelated with the returns from the investments of the large corporation's other divisions. Given the probabilities specified for Options A and B, which option would you pick in the best interests of the corporation's shareowners? Explain.