RISK ANALYSIS

Syndicate 6

5.
Investment : $ 10.000
Expected Return : $ 40.000, probability 20%
a.

Expected return E(R)

= (0,8 x (-10.000)) + (0,2 x40.000)
= (-8.000) + 8000 = 0

 b. Expected utilities of the project for individuals

Investment
Expected Return

Project A
Probability
10,000
0.8
40,000
0.2

Utility
-5
10

Investment
Expected Return

Project B
Probability
10,000
0.8
40,000
0.2

Utility
-5
20

Investment
Expected Return

Project C
Probability
10,000
0.8
40,000
0.2

Utility
-5
30

-4
2
-2

-4
4
0

-4
6
2

6
state of economy

probability

Product 1

profit

Utility

Expected

0.2

$50

$2,500

$10

Boom

0.5

$20

$1,600

$10

Normal

0.3

$0

$0

$0

Recession

Expected from profit

$20

Product 2

Boom

0.2

$30

$2,100

$6

Normal

0.4

$20

$1,600

$8

Recession

0.4

$10

$900
Expected from
profit

$4

M refers to dollars of profit

$18

Net present value

A. Risk free discount rate = 8%
A
1
2
3

B
110,000.00
40,000.00
60,000.00
40,000.00

104,000.00
30,000.00
80,000.00
50,000.00

$10,230.66

$32,056.50

Project B has higher NPV

Risk premium
Project A 2%
Project B 6%
Risk-adjusted rate
Project A: 2%+8% = 10%
Project B: 6%+8% = 14%
A

B
110,000.00

104,000.00

40,000.00

30,000.00

60,000.00

80,000.00

40,000.00

50,000.00

$6,003.01

$17,621.77