3I #2 PROBLEMS

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6.1 (Expected rate of return and risk) Carter Inc. is evaluating a security. One year Treasury bills are currently paying 9.1 percent. Calculate the investment's expected return and its standard deviation. Should Carter invest in this security?

Probability Return

.15 6%

.30 9%

.40 10%

.15 15%

10‑15.

(Risk-adjusted discount rates and risk classes) The G. Wolfe Corporation is examining two capital-budgeting projects with 5-year lives. The first, project A, is a replacement project; the second, project B, is a project unrelated to current operations. The G. Wolfe Corporation uses the risk-adjusted discount rate method and groups projects according to purpose, and then it uses a required rate of return or discount rate that has been preassigned to that purpose or risk class. The expected cash flows for these projects are given here:

	Project A	Project B
Initial investment	–$250,000	–$400,000
Cash inflows:
Year 1	$130,000	$135,000
Year 2	40,000	135,000
Year 3	50,000	135,000
Year 4	90,000	135,000
Year 5	130,000	135,000

The purpose/risk classes and preassigned required rates of return are as follows:

Purpose	Required Rate of Return
Replacement decision	12%
Modification or expansion of existing product line	15
Project unrelated to current operations	18
Research and development operations	20

Determine each project’s risk-adjusted net present value.

Prepare written responses to the following assignments.