Solar Designs is considering an investment in an expandedproduct line. Two possi
ID: 2662439 • Letter: S
Question
Solar Designs is considering an investment in an expandedproduct line. Two possible types of expansion are being considered.After investigating the possible outcomes the company made theestimates 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%
Optimistic
24%
30%
Determine the range of the rates ofreturn for each of the two projects.
Which project is less risky? Why?
If you were making the investment decision, which one would youchoose? Why? What does this imply about your feelings towardrisk?
Assume that expansion B’s most likely outcome is 21% peryear and that all other facts remain the same. Does this changeyour answer to part c? Why?
Expansion A
Expansion B
Initial investment
$12,000
$12,000
Annual rate of return
Pessimistic
16%
10%
Most likely
20%
20%
Optimistic
24%
30%
Explanation / Answer
a. Determine the range of the rates of return for each of the two projects. Range = Optimistic - Pessimistic Expansion A range = 8% Expansion B range = 20% b. Which project is less risky? Why? Although the most likely annual rate of return is the same for both expansion, the range of expansion A is far less than that of expansion B, which means expansion A is less risky. With less of a range, there is a better change that expansion A will be closer to the most likely annual rate of return. c. If you were making the investment decision, which one would you choose? Why? What does this imply about your feelings toward risk? I would go with expansion B because of the larger upside. This implies that I'm not risk adverdent and am more interested in the possiblity of a larger return. d. Assume that expansion B%u2019s most likely outcome is 21% per year and that all other facts remain the same. Does this change your answer to part c? Why? No because that would just lead me to lean further toward expansion B.
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