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How to measure risk between two investment projects

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1. Two investments have the following expected returns (net present values) and standard deviation of returns:
Project Expected Returns Standard Deviation
A $50,000 $40,000
B $250,000 $125,000

Which one is riskier? Why?

2. The manager of the Aerospace division of General Aeronautics has estimated the price can change for providing satellite launch services to commercial firms. Her most optimistic estimate (a price not expected to be exceeded more than 10 percent of the time) is $2 million. Her most pessimistic estimate (a lower price than this one is not expected more than 10 percent of the time) is $1 million. The expected value estimate is $1.5 million. The price distribution is believed to be approximately normal.

a. What is the expected price?
b. What is the standard deviation of the launch price?
c. What is the probability of receiving a price less than 1.2 million?

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Solution Preview

Problem 1: In order to answer this question,you have to remember that another way of expressing risk is the standard deviation.The standard deviation measures risk.So to re-state this question:Which project has the highest standard deviation?

Problem 2:
a) The expected price is the mean.How do you calculate the mean?Here we are given 2 estimates;$2 million and $1 million.Write down whatever is given,it will make your life easier.Once you have read the problem carefully,try to isolate what you neeed for your ...

Solution Summary

The answer is an explanation of how to use basic statistical concepts in order to measure risk when deciding between two or more investment projects.
Here you will find an explanation of the computation of the expected value,the z value and the standard deviation.
The solution is original therefore does not include any references.

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