Micro-Pub, Inc., is considering the purchase of one of two microfilm cameras, R

Question

Micro-Pub, Inc., is considering the purchase of one of two microfilm cameras, R and S. Both should provide benefits over a 10-year period, and each requires an initial investment of $4,000. Management has constructed the accompanying table of estimates of rates of return and probabilities for pessimistic, most likely, and optimistic results. a. Determine the range for the rate of return for each of the two cameras. b. Determine the expected value of return for each camera. c. Purchase of which camera is riskier?Why?

Explanation / Answer

(a)

Camera

Range

R

30% - 20% = 10%

S

35% - 15% = 20%

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(b)

Possible
Outcomes

Probability
Pri

Expected Return
ki

Weighted
Value (%)(ki ´ Pri)

Camera R

Pessimistic

0.25

20

5.00

Most likely

0.50

25

12.50

Optimistic

0.25

30

7.50

1.00

Expected Return

25.00

Camera S

Pessimistic

0.20

15

3.00

Most likely

0.55

25

13.75

Optimistic

0.25

35

8.75

1.00

Expected Return

25.50

================

c) Camera S is considered more risky than Camera R because it has a much broader range of outcomes. The risk-return trade-off is present because Camera S is more risky and also provides a higher return than Camera R.

Camera

Range

R

30% - 20% = 10%

S

35% - 15% = 20%

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