Write a 700- to 1,050-word paper in which you respond to the questions at the end of the case study. 1. P5-3
Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Sharon will evaluate each of these investments to decide whether they are superior to investments that her company already has in place, which have an expected return of 12% and a standard deviation of 6%. The expected returns and standard deviations of the investments are as follows:
Investment Expected Return Standard deviation X 14% 7% Y 12% 8% Z 10% 9%
a. If Sharon were risk neutral, which investments would she select? Explain why. She should accept Investments X and Y because these have higher returns than the 12% required return and the risk wouldn’t matter. b. If she were risk averse, which investments would she select? Why? She would then accept Investment X. It provides the highest return and has the least amount of risk. Investment X offers an increase in return this is because you are taking on more risk than what the organization earns. c. If she were risk seeking, which investments would she select? Why She would accept Investments Y and Z. They would be willing to take more risk knowing there may or may not be an increase in return.
d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why? Usually these managers are risk opposed and would choose Investment X, This is due to the fact it delivers the required increase in return for an
