Risk analysis Given the following information, calculate the expected value for

Question

Risk analysis Given the following information, calculate the expected value for Firm C's EPS. Data for Firms A and B are as follows: E(EPSA) = $5.10, and ?A = $3.61; E(EPSB) = $4.20, and ?B = $2.96.

Probability

0.1 0.2 0.4 0.2 0.1

Firm A: EPSA ($1.50) $1.80 $5.10 $8.40 $11.70

Firm B: EPSB (1.20) 1.50 4.20 6.90 9.60

Firm C: EPSC (2.40) 1.35 5.10 8.85 12.60

You are given that ?c = $4.11. Discuss the relative riskiness of the three firms' earnings using their respective coefficients of variation. Round your answer to two decimal places. CV A B C

Explanation / Answer

Expected rate of return of Firm C,

E(EPSC) = 0.1 * (-$2.40) + 0.2 * $1.35 + 0.4 * $5.10 + 0.2 * $8.85 + 0.1 * $12.60

= $5.10

Coefficient of variation of Firm A,

CVA = $3.61 / $5.10

= 0.708

Coefficient of variation of Firm B,

CVB = $2.96 / $4.20

= 0.705

Coefficient of variation of Firm C,

CVC = $4.11 / $5.10

= 0.806

Given the coefficient of variation, the relative riskiness of the Firm C is highest as indicated by higher ratio of standard deviation compared to the expected return.

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