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Chapter 4: Q2BP (page 439)

Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:

Possible Market Reaction Sales in Units Probabilities

Low response ....................................... 20 0.10

Moderate response .............................. 40 0.30

High response ...................................... 55 0.40

Very high response ............................... 70 0.20

a. What is the expected value of unit sales for the new product?

b. What is the standard deviation of unit sales?

Short Answer

Expert verified

The expected value of unit sales for the new product is computed as 50 units. The standard deviation is computed as 14.19.

Step by step solution

01

Computation of expected value of unit sales

Expectedvalueofunitsalesforthenewproduct=LowResponse+ModerateResponse+HighResponse+VeryHighResponse=20脳0.10+40脳0.30+55脳0.40+70脳0.20=50units

02

Computation of coefficient of Part B

Particulars

Sales

Deviation from the expected value ie (sales 鈥� 50 units)

(Sales 鈥� 50 units) ^2

Probability

Probability [(sales-50 units) ^2]

Low response

20

-30

900

0.1

90

Moderate response

40

-10

100

0.3

30

High Response

55

5

25

0.4

10

Very High Response

70

20

400

0.2

80

Variance

210

Standarddeviation=SquarerootofVariance=210=14.49

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Most popular questions from this chapter

You are asked to evaluate the following two projects for the Norton Corporation. Using the net present value method combined with the profitability index approach described in footnote 2 of this chapter, which project would you select? Use a discount rate of 14 percent.

Project X (Videotapes of the Weather Report) (\(20,000 Investment)

Year

Cash Flow

1

\)10,000

2

8,000

3

9,000

4

8,600

Project Y (Slow-Motion Replays of Commercials) (\(40,000 Investment)

Year

Cash Flow

1

\)20,000

2

13,000

3

14,000

4

16,000

The Short-Line Railroad is considering a \(140,000 investment in either of two companies. The cash flows are as follows:

Year

Electric Co

Water works

1

\)85,000

$30,000

2

25,000

25,000

3

30,000

85,000

4-10

10,000

10,000

a. Using the payback method, what will the decision be?

b. Explain why the answer in part a can be misleading.

Using Table 10-2:

a. Assume the interest rate in the market (yield to maturity) goes down to 8 percent for the 10 percent bonds. Using column 2, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year time period.

b. Assume the interest rate in the market (yield to maturity) goes up to 12 percent for the 10 percent bonds. Using column 3, indicate what the bond price will be with a 10-year, a 15-year, and a 20-year period.

c. Based on the information in part a, if you think interest rates in the market are going down, which bond would you choose to own?

d. Based on information in part b, if you think interest rates in the market are going up, which bond would you choose to own?

Wilson Oil Company issued bonds five years ago at $1,000 per bond. These bonds had a 25-year life when issued and the annual interest payment was then 15 percent. This return was in line with the required returns by bondholders at that point in time as described next:

Real rate of return ........................ 8%

Inflation premium ......................... 3

Risk premium .............................. 4

Total return ............................... 15%

Assume that 10 years later, due to bad publicity, the risk premium is now 7 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. The bonds have 15 years remaining until maturity. Compute the new price of the bond.

Gibson Appliance Co. is a very stable billion-dollar company with a sales growth of about 7 percent per year in good or bad economic conditions. Because of this stability (a coefficient of correlation with the economy of +0.4, and a standard deviation of sales of about 5 percent from the mean), Mr. Hoover, the vice president of finance, thinks the company could absorb a small risky company that could add quite a bit of return without increasing the company鈥檚 risk much. He is trying to decide which of the two companies he will buy, using the following figures. Gibson鈥檚 cost of capital is 12 percent.

Genetic Technology Co. (cost \(80 million)

Cash Flow for 10 Years (\) millions) Probability

\( 2 0.2

8 0.3

16 0.2

25 0.2

40 0.1

Silicon Microchip Co.(cost \)80 million)

Cash Flow for 10 Years (\( millions) Probability

\) 5 0.2

7 0.2

18 0.3

24 0.3

a. What is the expected cash flow from both companies?

b. Which company has the lower coefficient of variation?

c. Compute the net present value of each company.

d. Which company would you pick, based on the net present values?

e. Would you change your mind if you added the risk dimensions to the problem? Explain.

f. What if Genetic Technology Co. had a coefficient of correlation with the economy of -0.2 and Silicon Microchip Co. had one of +0.5? Which of these companies would give you the best portfolio effects for risk reduction?

g. What might be the effect of the acquisitions on the market value of Gibson Appliance Co.鈥檚 stock?
See all solutions

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