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Financial Management and Outcome Probability of Assumptions

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1. Modigliani and Associates has forecasted the following payoffs from a project:

Outcome Probability of Outcome Assumptions

$0 20% pessimistic
$5000 60% moderately successful
$7000 20% optimistic

What is the expected value of the outcomes?

a. $4000
b. $4400
c. $5000
d. Cannot be determined/depends upon which prediction is correct.

2. In order to evaluate risk, management may also set qualitative risk classes. Rank these four projects from the least to the most risky for a firm located in South America.

1.Completely new market in the United States
2.Completely new market in South America
3.Addition to normal product line
4.Repair to old machinery

a. 4, 3, 2, 1
b. 1, 2, 3, 4
c. 3, 4, 1, 2
d. 2, 3, 4, 1

4. A project has the following projected outcomes in dollars: $250, $350, and $500. The probabilities of their outcomes are 25%, 50%, and 25% respectively. What is the expected value of these outcomes?
a. $362.5
b. $89.4
c. $94.5
d. $178.3

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Answer 1: Use the following formula to determine the result:
.2x0 + .6x5,000 + .2x7,000
= 0 + 3,000 + 1,400
=4,400

So the answer is (B)

Answer 2:
Repair to old machinery is the least risky. This ...

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