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BUS 640 Week 1 Economics .pdf

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BUS 640 Week 1 Economics of Risk and Uncertainty Applied

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BUS 640 Week 1 Economics of Risk and Uncertainty Applied Problems

Economics of Risk and Uncertainty Applied Problems. Please,
complete the following 3 applied problems in a Word or Excel
document. Show all your calculations and explain your results. Submit
your assignment in the drop box by using the Assignment Submission

1. A generous university benefactor has agreed to donate a large
amount of money for student scholarships. The money can be

provided in one lump-sum of $10mln, or in parts, where $5.5mln can
be provided in year 1, and another $5.5mln can be provided in year 2.

Assuming the opportunity interest rate is 6%, what is the present
value of the second alternative? Which of the two alternatives should
be chosen and why?

How would your decision change if the opportunity interest rate was
12%? Please, show all your calculations.

2. Volkswagen is considering opening an Assembly Plant in
Chattanooga, Tennessee, for the production of its 2012 Passat,
tailored for the US market. The CEO of the company is considering
two potential options for the size of the plant: one is a large size with
a projected annual production of 150,000 cars, and the other one is a
smaller size plant, which is cheaper to build, but can only produce up
to 80,000 cars per year. Depending on the expected level of demand
for these cars in the US, Volkswagen has to decide which option is
more profitable. The discount rate is 6% and for simplicity purposes,
the CEO is only evaluating a two-year horizon. The initial factory setup
cost, the expected demand scenarios, profit, and probabilities are
shows in the below table. Calculate the Net Present Value in each of
the two options. Which option should the CEO choose and why?
Please, show all your calculations.

3. An angel investor is considering investing in one of two start-up
businesses and is evaluating the expected returns along with the risk
of each option in order to choose the better alternative.
Business 1 is an innovative protein energy drink, which has ENPV of
$100,000 with a standard deviation of $40,000.
Business 2 is a unique chicken wings dipping sauce with an ENPV of
$60,000 and a standard deviation of $25,000.

a) Apply the coefficient-of-variation decision criterion to these
alternatives to find out which is preferred by the angel investor,
assuming that he/she is risk-averse.

b) Apply the maximin criterion, assuming that the worst outcome in
Business 1 is to lose $5,000, whereas the worst outcome in Business 2
is to make only $5,000 in profit.

c) If you were the angel investor, what is your certainty equivalent for
these two projects? Are you risk-averse, risk-neutral, or risk-lover?

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