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Risk and Expected Returns

US Operations of Audi has been requested by the home office in Frankfurt to estimate the expected return on investment (ROI) and risk for 2010. Audi makes the most fuel-efficient motor vehicles in the US market, sales and profits and would benefit from higher fuel prices. On the other hand, a revelation of further sudden accelerator or other problems could weaken Audi sales and profits.

Part A
US Operations of Audi has developed four (4) possible scenarios with the following probabilities and estimates of return in 2010:

Scenario Probability Return
High gas prices, no further quality problems at Audi 0.20 24%
Med gas prices, no further major quality problems at Audi 0.25 18%
Med gas prices, additional quality problems at Audi 0.35 11%
Low gas prices, major quality Q&A problems Audi 0.20 - 5%

Part B
An engineer at the main Audi US factory has identified a solution to the major quality problems impacting Audi automobiles. The solution can be implemented quickly at low cost. With the quality problems resolved, US Operations of Audi has revised the four (4) possible scenarios with the following probabilities and estimates of return in 2010:

Scenario Probability Return
High gas prices, no further quality problems at Audi 0.25 26%
Mod gas prices, no further major quality problems at Audi 0.35 20%
Mod gas prices 0.30 14%
Low gas prices, major quality Q&A problems at Audi 0.10 - 5%

Calculate the expected return and risk associated with Audi for US operations in 2010 for both Parts A & B. Should Audi implement this solution? Why?

Solution Preview

RISK AND EXPECTED RETURNS
US Operations of Audi has been requested by the home office in Frankfurt to estimate the expected return on investment (ROI) and risk for 2010. Audi makes the most fuel-efficient motor vehicles in the US market, sales and profits and would benefit from higher fuel prices. On the other hand, a revelation of further sudden accelerator or other problems could weaken Audi sales and profits.

Part A
US Operations of Audi has developed four (4) possible scenarios with the following probabilities and estimates of return in 2010:
Scenario Probability Return
High gas prices, no further quality problems at Audi 0.2 24%
Med gas prices, ...

Solution Summary

The expert calculates the expected return and risk in this case.

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