Question

Risk and probability   ​Micro-Pub,Inc., is considering the purchase of one of two microfilm​ cameras,R and S. Both should provide benefits over a​ 10-yearperiod, and each requires an initial investment of

​$2,000. Management has constructed the following table of estimates of rates of return and probabilities for​ pessimistic,most​ likely,and optimistic​ results:

Initial investment	$2,000	1	$2,000	1
Annual rate of return
Pessimistic	16%	0.24	20%	0.22
Most likely	27%	0.45	26%	0.54
Optimistic	35%	0.31	30%	0.24

.

a.  Determine the range for the rate of return for each of the two cameras.

            The Range for the rate of return for Camera R is __% (Round to the nearest whole number)

b.  Determine the value of the expected return for each camera.

c.  Which camera purchase is​ riskier?​ Why?

Answer 1

A. The range for rate of return is difference between its optimistic rate of return (i.e. highest) and pessimistic rate of return i.e. lowest.

Therefore, range for rate of return for Camera R= 35% - 16%= 19%

Range for rate of return for Camera S= 30% - 20%= 10%

B. Expected Rate of Return is product of probability and different Rates of return

Expected rate of Return	Camera R			Camera S
	RoI	Probability	Expected Return	RoI	Probability	Expected Return
Pessimistic	16%	0.24	3.84	20%	0.22	4%
Most likely	27%	0.45	12.15	26%	0.54	14%
Optimistic	35%	0.31	10.85	30%	0.24	7%
	Total		26.84			25.64

Therefore, Expected Return of Camera R is 26.84% and Camera S is 25.64%.

C. Though expected rate of return is higher in case of purchase of Camera R but range of rate of return is also higher therefore there is more chaces for fluctuation as compared to Camera S. Therefore, purchase of camera R is riskier than camera S.