P8 – 3 Risk preferences Sharon Smith , the financial manager for Barnett Corporation , wishes to evaluate three prospective investments : X , Y , and Z . Sharon will evaluate each of these investments to decide whether they are superior to investments that her company already has in place , which have an expected return of 12 % and a standard deviation of 6 %. The expected returns and standard deviations of the investments are as follows :
a . If Sharon were risk neutral , which investments would she select ? Explain why .
b . If she were risk averse , which investments would she select ? Why ?
c . If she were risk seeking , which investments would she select ? Why ?
d . Given the traditional risk preference behavior exhibited by financial managers , which investment would be preferred ? Why ?
Investment Expected return Standard deviation X 14 % 7 % Y 12 8 Z 10 9
P8 – 4 Risk analysis Solar Designs is considering an investment in an expanded product line . Two possible types of expansion are being considered . After investigating the possible outcomes , the company made the estimates shown in the following table .
Expansion A Expansion B Initial investment $ 12,000 $ 12,000 Annual rate of return Pessimistic 16 % 10 % Most likely 20 % 20 %