| Critical Thinking 7 Assignment |
| NAME | Mantrako Crockett |
| GRADE | 74 |
| Questions | Points Possible | Points Attained | INSTRUCTOR COMMENTS |
| Salvatore 14: Discussion Question 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? | 10 | 8 | what is regret? What is maximum regret? |
| ANSWER: | The rationale behind the minimax regret rule is to minimize the maximum regret or opportunity cost of making the wrong decisions. Some of the more informal methods for dealing with uncertainty are the acquisition of more information, which its reduces uncertainty when dealing with a particular strategy or event and issues arise from it. Acquiring more information can be costly, but in in the long-term it could potential be a good investment. Referral to authority is gaining the opinion of a professional service, which offers expert informative information to help reduce uncertainty. Although it is good to have more information it is hard to utilize referral to authority for long-term investments. Controlling the business environment is another way to deal with uncertainty, but it can be limited in the long run. Diversification is another method to deal with uncertainty, which allows companies to have more than one resource to rely on financial, especially when another product is not profitable. Diversification allows for financial flexibility among multiple things, vice financial reliance on one thing. The less formal methods are useful by business professionals or manager who understand the informal methods, and require alternate means to deal with uncertainty. |
| Salvatore 14: Discussion Question 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? | 5 | 4 | higher rates don't reduce risk, but cover the costs of higher default rates. However they drive away good risks…cc companies can reduce the problem by credit checks, etc. |
| ANSWER: | Adverse selection problem arrise by asymmetric information before the transaction between the buyer and seller. In the credit card market, it occurs when potential borrowers are liabilites because of certain issues (bad credit/high risk) are the ones who most actively seek out a loan. To reduce the adverse selection problem, credit card can raise interest rates to help reduce and mitigate the risk of defaulting on loans. However,higher interest rates will weakenthe economy |
| Salvatore 14: 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:
Investment A Investment B
Income Probability Income Probability
4000 0.2 4000 0.3
5000 0.3 6000 0.4
6000 0.3 8000 0.3
7000 0.2
(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?
NOTE: Use table 14-4 as reference | 5 | 5 |
| ANSWER: | See SP7_1.1 |
| Salvatore 14: Spreadsheet Problem 2 | An individual is considering two investment projects. Project A will return a zero profi t if conditions are poor, a profi t of $ 4 if conditions are good, and a profi t of $ 8 if conditions are excellent. Project B will return a profi t of $ 2 if conditions are poor, a profi t of $ 3 if conditions are good, and a profi t 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?
NOTE: Use tables 14-5 and 14-6 as reference | 5 | 5 |
| ANSWER: | See SP7_1.2 |
| Froeb et al 17: IP 17-1 | You’re the manager of global opportunities for a
U.S. manufacturer, who is considering expanding
sales into Asia. Your market research has identi-
fied the market potential in Malaysia, Philippines,
and Singapore as described next:
Success Level
Big Mediocre Failure
Malaysia
Probability 0.3 0.3 0.4
Units 1,200,000 600,000 0
Philippines
Probability 0.3 0.5 0.2
Units 1,000,000 320,000 0
Singapore
Probability 0.7 0.2 0.1
Units 700,000 400,000 0
The product sells for $10 and has unit costs
of $8. If you can enter only one market, and the
cost of entering the market (regardless of which
market you select) is $250,000, should you enter
one of these markets? If so, which one? If you
enter, what is your expected profit?
| 5 | 5 |
| ANSWER: | See sheet Froeb et al 17 IP 17-1 |
| Froeb et al 17: IP 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 second-hand 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? | 5 | 3 | 300K is right price but for a different reason. Your calculation is basically assuming expected profit from different prices. The probability it sells for a particular price is the probability someone values it at that price or more than that price.The expected profits for these prices are below.
If price = 300000, profit would be 50000. The probability it sells is 75%, and expected profit is thus 0.75*500000 = 37500
If price = 350000, profit would be 100000. The probability it sells is probability it sells is 35%, and expected profit is thus 0.35*100000 = 35000
If price = 400000, profit would be 150000. The probability it sells is 10%, and expected profit is thus 0.1*150000 = 25000
Hence the price that maximizes profits is $300,000
|
| ANSWER: | Although 400,000 would maxmize profit but there is only a 10% chance it would sell. The best option would be to sell it for $300,000. 0.4(300,000) + 350,000(0.25) + 400,000(0.10) + 0.25(0)120,000+87,500+40,000+0=$247,500 (expected value) so 300,000 is the best option. | |
| Froeb et al 19: IP 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. | 5 | 4 | But what is the problem created by the adverse selection? The adverse selection problem would be the buyer would be unwilling to pay the full value of the product, given the risk he feels he faces. As a result, the seller may not be able to make enough revenue to cover his costs and thus the sale does not occur.
|
| ANSWER: | The seller or producer knows the true value of a product or if it even works wereas the potential buyer does not. The buyer is always skeptical of buying a new product because of the unknowns. A seller could offer to let the buyer use an item prior to paying to help build there confidence about the product, and see that they product will do as advertised. The seller wouldnt make this kind of offer if the product doesn't work. |
| Froev et al 19: IP 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 Value 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?
NOTE: Need to consider adverse selection. | 10 | 10 |
| ANSWER: | See sheet Froev et al 19 IP 19-6 |
| Salvatore 15: 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? | 5 | 5 |
| ANSWER: | A) NPV is the net present value and IRR is the internal rate of return. NPV has direct value of the dollar contribution to the stockholders where as IRR exhibits the return on the original money that is invested. These methods can provide contradicting results when dealing with exclusive investments .B) When a project is independent, the NPV and IRR will always have the same result. However, when projects are mutually exclusive, meaning the decision being made must be one project or another, the NPV and .IRR do not always correlate. C)For mutually exclusive projects, the NPV method is a better method to use. This is because the NPV method uses realistically reinvestment assumptions and is a better indicator of profitability and shareholder wealth. In addition, the NPV calculation with accurately aid the decision maker in choosing the correct accept or regret decision regardless of the existence of non-normal cash flows, variations in project size and/or timing. |
| Salvatore 15: Problem 8 | John Piderit, the general manager 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. (a) Which project(s) would the firm undertake if it used the NPV investment criterion? (b) Is this the correct decision? Why?
NOTE: Remember the firm has a limited capital budget of $2.4 million for the coming year. In other words, the firm faces the capital rationing and should use the profitability index as its investment criterion (pp. 654–655). | 10 | 10 |
| ANSWER: | See Salvatore 15: Problem 8 |
| Salvatore 15: Problem 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 fi rm.
NOTE: Use the dividend valuation model (pp. 657–658). “A share of the common stock of the company currently sells for eight times current dividends"
| 10 | 10 |
| ANSWER: | Ke = D/P + gKe = 1/8 + 0.075Cost of Equity Capital= 0.2 |
| Salvatore 15: 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. 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?
NOTE: Change the present value coefficient from 1/(1+0.5)n to 1/(1+0.05)n. That is the discount rate of 5% instead of 50% | 5 | 5 |
| ANSWER: | SEE SP7_2 |
CarolinaPanther007
ctq7.xlsx
