# Risk and return

Lunar 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%

Optimistic 24% 30%

a. determine the range of the rates of return for each of the two projects

b. which project is less risky? why?

c. if you were making the investment decision, which one would you choose? why? what doe this imply about your feelings toward risk?

d. assume that expansion B's most likely outcome is 21% per year and that all other facts remain the same. Does this change your answer to part c? Why?

https://brainmass.com/business/beta-and-required-return-of-a-project/risk-and-return-226862

#### Solution Preview

Lunar 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 ...

#### Solution Summary

Determines the risk and returns for two projects.

Expected returns Stocks X and Y have the following probability distributions of expected future returns

Please assist me in accurately answering the following questions. I am having a difficult time solving the questions.

8-6 Expected returns Stocks X and Y have the following probability distributions of

expected future returns:

Probability X Y

0.1 (10%) (35%)

0.2 2 0

0.4 12 20

0.2 20 25

0.1 38 45

a. Calculate the expected rate of return, r?Y, for Stock Y. (r?X _ 12%.)

b. Calculate the standard deviation of expected returns, _X , for Stock X. (_Y _ 20.35%.)Now calculate the coefficient of variation for Stock Y. Is it possible that most investors might regard Stock Y as being less risky than Stock X? Explain.

8-20 Realized rates of return Stocks A and B have the following historical returns:

Year Stock A's Returns, rA Stock B's Returns, rB

2001 (18.00%) (14.50%)

2002 33.00 21.80

2003 15.00 30.50

2004 (0.50) (7.60)

2005 27.00 26.30

a. Calculate the average rate of return for each stock during the period 2001 through 2005.

b. Assume that someone held a portfolio consisting of 50 percent of Stock A and 50 percent of Stock B. What would the realized rate of return on the portfolio have been in each year? What would the average return on the portfolio have been during this period?

c. Calculate the standard deviation of returns for each stock and for the portfolio.

d. Calculate the coefficient of variation for each stock and for the portfolio.

e. Assuming you are a risk-averse investor, would you prefer to hold Stock A, Stock B, or the portfolio? Why?