## Problems

P14.1 Risk Preferences. Identify each of the following as being consistent with risk-averse, risk-neutral, or risk-seeking behavior in investment project selection. Explain your answers.

A. Larger risk premiums for riskier projects

B. Preference for smaller, as opposed to larger, coefficients of variation

C. Valuing certain sums and expected risky sums of equal dollar amounts equally

D. Having an increasing marginal utility of money

E. Ignoring the risk levels of investment alternatives

P14.2 Certainty Equivalents. The certainty equivalent concept can be widely employed in the analysis of personal and business decision making. Indicate whether each of the following statements is true or false and explain why:

A. The appropriate certainty equivalent adjustment factor, a, indicates the minimum price in certain dollars that an individual should be willing to pay per risky dollar of expected return.

B. An a ^ 1 implies that a certain sum and a risky expected return of different dollar amounts provide equivalent utility to a given decision maker.

C. If previously accepted projects with similar risk have as in a range from a = 0.4 to a = 0.5, an investment with an expected return of \$150,000 is acceptable at a cost of \$50,000.

D. A project for which NPV > 0 using an appropriate risk-adjusted discount rate has an implied a factor that is too large to allow project acceptance.

E. State lotteries that pay out 50% of the revenues that they generate require players who place at least a certain \$2 value on each \$1 of expected risky return.

P14.3 Expected Value. Duddy Kravitz, a broker with Caveat Emptor, Ltd., offers free investment seminars to local PTA groups. On average, Kravitz expects 1% of seminar participants to purchase \$25,000 in tax-sheltered investments and 5% to purchase \$5,000 in stocks and bonds. Kravitz earns a 4% net commission on tax shelters and a 1% commission on stocks and bonds. Calculate Kravitz's expected net commissions per seminar if attendance averages 10 persons.

P14.4 Probability Concepts. Aquarius Products, Inc., has just completed development of a new line of skin-care products. Preliminary market research indicates two feasible marketing strategies: (1) creating general consumer acceptance through media advertising or (2) creating distributor acceptance through intensive personal selling by company representatives. The marketing manager has developed the following estimates for sales under each alternative:

 Probability Sales Probability Sales