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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

Question: Beverly Hills started a paper route on January 1. Every three months, she deposits $550 in her bank account, which earns 8 percent annually but is compounded quarterly. Four years later, she used the entire balance in her bank account to invest in an investment at 7 percent annually. How much will she have after three more years?

Why is the remaining time to maturity an important factor in evaluating the impact of a change in yield to maturity on bond prices?

Question:Masco Oil and Gas Company is a very large company with common stock listed on the New York Stock Exchange and bonds traded over the counter. As of the current balance sheet, it has three bond issues outstanding:

\(150 million of 10 percent series ....... 2026

\)50 million of 7 percent series ........... 2020

\(75 million of 5 percent series ........... 2016

The vice president of finance is planning to sell \)75 million of bonds next year to replace the debt due to expire in 2016. Present market yields on similar Baa-rated bonds are 12.1 percent. Masco also has \(90 million of 7.5 percent noncallable preferred stock outstanding, and it has no intentions of selling any preferred stock at any time in the future. The preferred stock is currently priced at \)80 per share, and its dividend per share is \(7.80.

The company has had very volatile earnings, but its dividends per share have had a very stable growth rate of 8 percent and this will continue. The expected dividend (D1) is \)1.90 per share, and the common stock is selling for \(40 per share. The company鈥檚 investment banker has quoted the following flotation costs to Masco: \)2.50 per share for preferred stock and $2.20 per share for common stock.

On the advice of its investment banker, Masco has kept its debt at 50 percent of assets and its equity at 50 percent. Masco sees no need to sell either common or preferred stock in the foreseeable future as it has generated enough internal funds for its investment needs when these funds are combined with debt financing. Masco鈥檚 corporate tax rate is 40 percent. Compute the cost of capital for the following:

a. Bond (debt) (Kd).

b. Preferred stock (Kp).

c. Common equity in the form of retained earnings (Ke).

d. New common stock (Kn).

e. Weighted average cost of capital.

Tim Trepid is highly risk-averse while Mike Macho actually enjoys taking a risk.

a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your choice.

Investments

Returns:

Expected Value

Standard Deviation

Buy stocks ..................................... \( 9,140 \) 6,140

Buy bonds ..................................... 7,680 2,560

Buy commodity futures ................. 19,100 26,700

Buy options ................................... 17,700 18,200

b. Which one of the four investments should Mike choose?

If a corporation has projects that will earn more than the cost of capital, should it ration capital? (LO12-5)
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