Exam 16: Risk Analysis

A project with a 50% chance of earning $0 and a 50% chance of earning $100 has a standard deviation of:

Standard Normal. Personal Business Cards, Inc. supplies customized business cards to commercial and individual customers. Although paper, ink, and other costs cannot be determined precisely, Personal anticipates that costs will be normally distributed around a mean of $15 per unit (each 500-card order) with a standard deviation of $2 per unit. A. What is the probability that Personal would make a profit at a price of $15 per unit? B. Calculate the unit price necessary to give Personal a 95% chance of making a profit on the order. C. If Personal submits a successful bid of $18.20 per unit, what is the probability that it will make a profit?

Decision Trees. Arnie Becker, an attorney with Dewey, Cheetum & Howe in Los Angeles, California, must serve a subpoena to an individual in New York, New York by 10:00 a.m. tomorrow morning. If the subpoena is delivered late, Becker stands to lose $5,000 in fees. The subpoena can be delivered by mail at a cost of $25, or by courier at a cost of $225. Based on passed experience, Becker assigns a 99% change of on-time delivery using the courier service. Because Express Mail is a relatively new service, Becker does not know the probability of on-time delivery using this service. A. Construct a decision tree for this problem and calculate the minimum probability of on-time delivery for Express Mail that would make Becker indifferent to the two delivery services.

A decision standard that selects the alternative with the best of the worst possible outcomes is:

Certainty Equivalents. Rabbit Food, Inc., is a rapidly growing chain of health food restaurants. The company has a limited amount of capital for expansion, and must carefully weigh available alternatives. Currently, the company is considering opening restaurants in Fresno and/or Pasadena, California. Projections for the two potential outlets are: Each restaurant would involve a capital expenditure of $2.5 million, plus land acquisition costs of $500,000 for Fresno and $1.5 million for Pasadena. The company uses the 10% an estimate of a minimal risk-free annual opportunity cost of investment capital. A. Calculate the expected value, standard deviation, and coefficient of variation for each outlet's profit contribution. B. Calculate the minimum certainty equivalent adjustment factor for each restaurant's cash flows that would justify investment in each outlet. C. Assuming the management of Rabbit Food is risk averse, and uses the certainty equivalent method in decision making, which is the more attractive outlet? Why?

For two projects of differing sizes, the project that is less risky has the:

Probability Analysis. The Seattle HMO, Inc. is considering entering into a data processing contract with a leading consulting firm. Entering into such an agreement would require a current investment outlay of $200,000. The following net cash flows (cost savings) will be generated each year over the ten-year life of the management contract: A. Calculate the expected cash flow. B. Calculate the standard deviation and coefficient of variation of cash flows (risk). C. Calculate the expected net present value for the investment if the firm uses a discount rate of 20%. Should the investment be undertaken?

A certainty-equivalent adjustment factor a = 0.8 is consistent with risk:

For a risk seeker the marginal utility of money is:

A risk seeking decision maker displays:

A valuation model that explicitly accounts for risk can be written as:

Economic risk is a situation where:

Uncertainty is present when:

A project with a 75% chance of earning $4,000 in profit and a 25% chance of earning $12,000 in profit has an expected value of:

Standard Normal. Chip Technologies, Inc. supplies wafer-thin computer chips to industrial customers. Although labor and material costs cannot be determined precisely, CTI anticipates that costs will be normally distributed around a mean of $3 per unit with a standard deviation of 20¢ per unit. A. What is the probability that CTI would make a profit at a price of $3 per unit? B. Calculate the unit price necessary to give CTI a 95% chance of making a profit on the order. C. If CTI signs a contract to supply chips at a price of $3.20 per unit, what is the probability that it will make a profit?

Risk Attitudes. Identify each of the following as consistent with risk-averse, risk-neutral, or risk-seeking behavior in investment project selection: A. Ignoring risk levels of investment alternatives. B. Larger risk premiums for riskier projects. C. Valuing equally certain sums and expected risky sums of equal dollar amounts. D. Increasing marginal utility of money. E. Preference for larger, as opposed to smaller, coefficients of variation.

Economic risk is the:

Risk neutrality implies a:

Certainty Equivalents. Rajun Cajun's, Ltd., is a rapidly growing chain of Cajun-style cuisine restaurants. The company has a limited amount of capital for expansion, and must carefully weigh available alternatives. Currently, the company is considering opening restaurants in Montgomery, Alabama and/or Pensacola Beach, Florida. Projections for the two potential outlets are: Each restaurant would involve a capital expenditure of $1.5 million, and the company uses the 10% yield on risk-free U.S. Treasury bills to calculate the risk-free annual opportunity cost of investment capital. A. Calculate the expected value, standard deviation, and coefficient of variation for each outlet's profit contribution. B. Calculate the minimum certainty equivalent adjustment factor for each restaurant's cash flows that would justify investment in each outlet.

The chance of loss associated with a given managerial decision is: