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# Investment in a security, Risk-adjusted net present value

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6.1 (Expected rate of return and risk) Carter Inc. is evaluating a security. One-year Treasury bills are currently paying 9.1 percent. Calculate the investment's expected return and its standard deviation. Should Carter invest in this security?

Probability Return
0.15 6%
0.3 9%
0.4 10%
0.15 15%

10.15) (Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk-adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here:

Project A Project B
Initial investment -\$250,000 -\$400,000
Cash inflows:
Year 1 \$130,000 \$135,000
Year 2 40,000 135,000
Year 3 50,000 135,000
Year 4 90,000 135,000
Year 5 130,000 135,000

The purpose/risk classes and preassigned required rates of return are as follows:

Purpose Required Rate of Return
Replacement decision 12% Project A
Modification or expansion of existing product line 15
Project unrelated to current operations 18 Project B
Research and development operations 20

Determine each project's risk-adjusted net present value.

Attached you will find the PDF document to some practice study problems.
Study problem 6-1 in Chapter 6, Study problem 10-15 in Chapter 10

#### Solution Preview

6.1 (Expected rate of return and risk) Carter Inc. is evaluating a security. One-year Treasury bills are currently paying 9.1 percent. Calculate the investment's expected return and its standard deviation. Should Carter invest in this security?

Probability Return
0.15 6%
0.3 9%
0.4 10%
0.15 15%

Probability return return x Probability Difference from mean, i.e.9.85% Difference 2 Probability x Difference 2
0.15 6% 0.90% -3.85% 0.00148225 0.0002223375
=6.%x0.15 =6.% - 9.85% =-0.0385^2 =0.15 x 0.00148225
0.30 9% 2.70% -0.85% 0.00007225 0.0000216750
=9.%x0.3 =9.% - 9.85% =-0.0085^2 =0.3 x 0.00007225
0.40 10% 4.00% 0.15% 0.00000225 0.0000009000
=10.%x0.4 =10.% - 9.85% =0.0015^2 =0.4 x 0.00000225
0.15 15% 2.25% 5.15% 0.00265225 0.0003978375
=15.%x0.15 =15.% - 9.85% =0.0515^2 =0.15 x 0.00265225
1.00 Total= 9.85% 0.00064275

Expected ...

#### Solution Summary

Answers 2 questions on evaluating a security for investment and risk-adjusted net present value.

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