Posted: February 5th, 2015

RISK: FREQUENCY DISTRIBUTION, PROBABILITIES, AND EXPECTED VALUE

Module 2 – SLP

RISK: FREQUENCY DISTRIBUTION, PROBABILITIES, AND EXPECTED VALUE
Scenario: You are an entrepreneur that has several business investments in real estate, restaurants, and retail stores. You are looking for your next investment

opportunity for you and your private equity investment company. You have found two possible alternatives to invest in that will payoff in the next 10 years. Here are

the descriptions of the two options.

Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the

possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.

High NPV: $5 million, Pr = 0.5

Medium NPV: $2 million, Pr = 0.3

Low NPV: $0, Pr = 0.2

Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It

has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are

your estimates of the Net Present Value of the cash flow and probabilities.

High NPV: $3 million, Pr = 0.75

Medium NPV: $2 million, Pr = 0.15

Low NPV: $1 million, Pr = 0.1

Assignment

Develop an analysis of these two investments. Use expected value to determine which of these you should choose. Do your analysis in Excel.

Write a report to your private investment company and explain your analysis and your recommendation. Provide a rationale for your decision.

Upload both your written report and Excel file to the SLP 2 Dropbox.

BONUS: If these two options could be made to be equal, what would have to change in the payoffs in Option A to make it equal to Option B (not the investment amount)?

SLP Assignment Expectations
Analysis

Accurate and complete analysis in Excel.
Written Report

Accurate and complete review of the situation.
Accurate and complete discussion of the analysis.
Accurate and complete Recommendation
Accurate and complete explanation of the rationale and logic.
———-
Added on 04.02.2015 05:20
APOLOGIES THOSE WHERE THE WRONG INSTRUCTIONS
BELOW ARE THE CORRECT ONES:
Module 3 – SLP

LINEAR REGRESSION FORECASTING AND DECISION TREES
Scenario: Using the situation from SLP2, recall that you are deciding between two investments. However, they each require a different initial investment amount. And

you also have a third option, to invest in a 10 year municipal bond with a very high return. Here are the investment options with the augmented data.

Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the

possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.

Required initial investment: $0.75 million

High NPV: $5 million, Pr = 0.5

Medium NPV: $2 million, Pr = 0.3

Low NPV: $0, Pr = 0.2

Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It

has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are

your estimates of the Net Present Value of the cash flow and probabilities.

Required initial investment: $0.55 million

High NPV: $3 million, Pr = 0.75

Medium NPV: $2 million, Pr = 0.15

Low NPV: $1 million, Pr = 0.1

Note that this option requires less investment, so there is $0.2 million available, which can be invested in the same bonds as Option C. The NPV of this investment in

this option (B) is $0.4 million.

Option C: High Yield Municipal Bonds. This option has low risk and is assumed to be a Certainty. So there is only one outcome with probability of 1.0
Required initial investment: $0.75 million
NPV: $1.5 million, Pr = 1.0

Assignment

Develop an analysis of these three investments. Use expected NPV to determine which of these you should choose. Be sure to include all cash flows to generate the total

NPV of each alternative. Do your analysis in Excel using decision tree.

Write a report to your private investment company and explain your analysis and your recommendation. Provide a rationale for your decision.

Upload both your written report and Excel file with the decision tree analysis to the SLP 3 Dropbox.

BONUS: If the two options A and B could be made to be equal, what would have to change in the NPVs in Option A to make it equal to Option B?

SLP Assignment Expectations
Analysis

Accurate and complete analysis in Excel.
Written Report

Accurate and complete review of the situation.
Accurate and complete discussion of the analysis.
Accurate and complete Recommendation
Accurate and complete explanation of the rationale and logic.
Attention, Please note that you are not supposed to upload any files with additional pages (extra instructions) until Administration informs you on the payment

receipt.