Laura Coplai
Liberty University
BUSI 620:B01 – Global Economic Environment
Critical Thinking 7
Salvatore’s
Chapter 14:
Discussion
Questions:
12.What is
the rationale behind the minimax regret rule?
What are some less formal and precise methods of dealing with
uncertainty? When are these useful?
15.How does
the adverse selection problem arise in the credit-card market? How do credit-card companies reduce the
adverse selection problem that they face?
To what complaint does this give rise?
Spreadsheet problem 1.An individual has to choose between investment
A and investment B. The individual
estimates that the income and probability of the income from each investment
are as given in the following table: (see Excel)
(a). Using
Excel’s statistical tools, calculate the standard deviation of the distribution
of each investment.
(b). Which
of the two investments is more risky?
(c). Which
investment should the individual choose?
Spreadsheet problem 2.An individual is considering two investment
projects. Project A will return a zero
profit if conditions are poor, a profit of $4 if conditions are good, and a
profit of $8 if conditions are excellent.
Project B will return a profit of $2 if conditions are poor, a profit of
$3 if conditions are good, and a profit of $4 if conditions are excellent. The probability distribution of conditions is
as follows:
Conditions: Poor Good Excellent
Probability: 40% 50% 10%
(a). Using
Excel, calculate the expected value of each project and identify the preferred
project according to this criterion.
(b). Assume
that the individual’s utility function for profit is U(X) = X – 0.05X2. Calculate the expected utility of each
project and identify the preferred project according to this criterion
(c).Is this
individual risk averse, risk neutral, or risk seeking? Why?
17-1.You’re
the manager of global opportunities for a U.S. manufacturer, who is considering
expanding sales into Europe. Your market
research has identified three potential market opportunities: England, France,
and Germany. If you enter the English
market, you have a 0.5 chance of big success (selling 100,000 units at a
per-unit profit of $8), a 0.3 chance of moderate success (selling 60,000 units
at a per-unit profit of $6), and a 0.2 chance of failure (selling nothing). If you enter the French market, you have a
0.4 chance of big success (selling 120,000 units at a per-unit profit of $9), a
0.4 chance of moderate success (selling 50,000 units at a per-unit profit of
$6), and a 0.2 chance of failure (selling nothing). If you enter the German market, you have a
0.2 chance of huge success (selling 150,000 units at a per-unit profit of $10),
a 0.5 chance of moderate success (selling 70,000 units at a per-unit profit of
$6), and a 0.3 chance of failure (selling nothing). If you can enter only one market, and the
costs of entering the market (regardless of which market you select) is
$250,000, should you enter one of the European markets? If so, which one? If you enter, what is your expected profit?
17-4.Your company
has a customer who is shutting down a production line, and it is your
responsibility to dispose of the extrusion machine. The company could keep it in inventory for
possible future product and estimates that the reservation value is
$250,000. Your dealings on the
secondhand market lead you to believe that there is a 0.4 chance a random buyer
will pay $300,000, a 0.25 chance the buyer will pay $350,000, a 0.1 chance the
buyer will pay $400,000, and a 0.25 chance it will not sell. If you must commit to a posted price, what
price maximizes profits?
19-5.Soft
selling occurs when a buyer is skeptical of the usefulness of a product and the
seller offers to set a price that depends on realized value. For example, suppose you’re trying to sell a
company a new accounting system that will reduce costs by 10%. Instead of naming a price, you offer to give
them the product in exchange for 50% of their cost savings. Describe the information asymmetry, the
adverse selection problem, and why soft selling is a successful signal.
19-6.You need
to hire some new employees to staff your start-up venture. You know that potential employees are
distributed throughout the population as follows, but you can’t distinguish
among them:
|
Employee |
Probability |
|
$50,000 |
0.25 |
|
$60,000 |
0.25 |
|
$70,000 |
0.25 |
|
$80,000 |
0.25 |
What is
the expected value of five employees you hire?
Discussion
Question:
7.(a). When
can the NPV and the IRR methods of evaluating investment projects provide
contradictory results?
(b). How can
this arise?
(c). Which
method should then be used? Why?
Problems:
8.John
Piderit, the general manger of the Western Tool Company, is considering
introducing some new tools to the company’s product line. The top management of the firm has identified
three types of tools (referred to as projects A, B, and C). The various divisions of the firm have provided
the data given in the following table on these three possible projects. The company has a limited capital budget of
$2.4 million for the coming year.
|
|
Project |
Project |
Project |
|
Present value of |
$3,000,000 |
$1,750,000 |
$1,400,000 |
|
Initial cost of |
2,400,000 |
1,300,000 |
1,100,000 |
(a). Which
project(s) would the firm undertake if it used the NPV investment criterion?
(b). Is this
the correct decision? Why?
10.The
MacBurger Company, a chain of fast-food restaurants, expects to earn $200
million after taxes for the current year.
The company has a policy of paying out half of its net after-tax income
to the holders of the company’s 100 million shares of common stock. A share of the common stock of the company
currently sells for eight times current dividends. Management and outside analysts expect the
growth rate of earnings and dividends for the company to be 7.5 percent per
year. Calculate the cost of equity
capital to this firm.
Spreadsheet problem 1.The benefits and costs of an investment project
(the purchase of a piece of machinery) are those given in the following table.
(see Excel) In Excel, calculate net
revenue, or the revenue from the investment minus the costs; the present value
coefficient for every year; and the present value of the net revenue. Add together column F to get the net present
value of the project. Should the firm
purchase the machine?
