# Practice Problems Chapter 13 Recommended 1-3, 6, 8, 21,22,24

Discussion Questions
13-1. Risk-averse corporate managers are not unwilling to take risks, but will require a higher return from risky investments. There must be a premium or additional compensation for risk taking. 13-2. Risk may be defined in terms of the variability of outcomes from a given investment. The greater the variability, the greater the risk. Risk may be measured in terms of the coefficient of variation, in which we divide the standard deviation (or measure of dispersion) by the mean. We also may measure risk in terms of beta, in which we determine the volatility of returns on an individual stock relative to a stock market index. 13-3. The standard deviation is an absolute measure of dispersion, while the coefficient of variation is a relative measure that allows us to relate the standard deviation to the mean. The coefficient of variation is a better measure of dispersion when we wish to consider the relative size of the standard deviation or compare two or more investments of different size. 13-4. Risk may be introduced into the capital budgeting process by requiring higher returns for risky investments. One method of achieving this is to use higher discount rates for riskier investments. This risk-adjusted discount rate approach specifies different discount rates for different risk categories as measured by the coefficient of variation or some other factor. Other methods, such as the certainty equivalent approach, may also be used. 13-5. Referring to Table 13-3, the following order would be correct: • • • • • • repair old machinery (c) new equipment (a) addition to normal product line (f) new product in related market (e) completely new market (b) new product in foreign market (d)

13-6. In order to minimize risk, the firm that is positively correlated with the economy should select the two projects that are negatively correlated with the economy. 13-7. A discount rate combines the effects of risk and time value of money in one evaluation tool. A certainty equivalent deals first with risk by converting uncertain cash flows to ‘certainty equivalents’, and then discounts at the risk free rate to consider the time value of money.

Foundations of Fin. Mgt.

S-425

8/E Cdn. • Block, Hirt, Short

13-8. Simulation is one way of dealing with the uncertainty involved in forecasting the outcomes of capital budgeting projects or other types of decisions. A Monte Carlo simulation model uses random variables for inputs. By programming the computer to randomly select inputs from probability distributions, the outcomes generated by a simulation are distributed about a mean and instead of generating one return or net present value, a range of outcomes with standard deviations are provided. 13-9. Sensitivity analysis only adjusts one variable at a time. In all likelihood variables are interdependent and if one changes the others will likely change as well. Sensitivity analysis misses this dynamism. As well sensitivity analysis does not assess risk, it only points out possible outcomes and we are left to assign probabilities. With today’s ease of spreadsheet production on the PC one can turn out endless analysis, which, without a plan will become meaningless. 13-10. Decision trees help lay out the sequence of decisions that are to be made and present a tabular or graphical comparison resembling the branches of a tree which highlights the difference between investment choices. 13-11. The firm should attempt to construct a chart showing the risk-return characteristics for every possible set of 20. By using a procedure similar to that indicated in Figure 13-11, the best risk-return trade-offs or efficient frontier can be determined. We then can decide where we wish to be along this line. 13-12. High profits alone will not necessarily lead to a high market value for common stock. To the extent large or unnecessary risks are taken, a higher discount rate and lower valuation may be assigned to shares. Only by attempting to match the appropriate levels for risk and return can we hope to maximize our overall value in the market.

Internet Resources and Questions

Foundations of Fin. Mgt.

S-426

8/E Cdn. • Block, Hirt, Short

a.40 . D 20 40 55 70 D 50 50 50 50 σ = ∑ (D − D ) P (D– D ) – 30 – 10 + 5 + 20 (D– D )2 900 100 25 400 P .10 . 20 40 55 70 D . Mgt.Problems 13-1. Hirt.40 .30 Shack Homebuilders Limited D = ∑ DP P 8 30 42 80 DP = D Foundations of Fin.10 . a. Short .49 13-2.20 Myers Business Systems D = ∑ DP P 2 12 22 14 50 DP = D 2 b. 40 60 140 D .50 . • Block.20 .20 (D– D )2P 90 30 10 80 210 σ = 210 = 14. S-427 8/E Cdn.30 .30 .

20 = .600 P . Mgt.600 σ = 1.24) A (. C has a larger standard deviation and so is riskier than B for the same expected return.50 .0 13-3.20 . You would not need to use the coefficient of variation.000 \$600/ \$4.000 \$800/ \$10.200/ \$8.000 = .40) 13-4. Since B and C have the same expected value.30 (D– D )2P 320 200 1.600 = 40.200/ \$5.080 1.24 = .15) C (.000 \$3.20) D (. Five alternatives Coefficient of variation (V ) = A B C D E \$1.08) B (.000 \$800/ \$4.15 = . Hirt.08 σ D Ranking from lowest to highest E (.b. Short .40 = . Foundations of Fin. they can be evaluated based solely on their standard deviations of return. • Block. S-428 8/E Cdn.600 400 3. D 40 60 140 D 80 80 80 σ = ∑ (D − D ) P 2 (D– D ) – 40 – 20 + 60 (D– D )2 1.

S-429 8/E Cdn.11 a. Tim should select bonds. Construction Project A B C D \$138. Mike should select commodities.55 . This may be related to the inability to make forecasts far into the future. 13-7. There is more uncertainty.53 0. Short . Foundations of Fin.23 1.000 \$403. b.000/ \$88.000/ \$674.66 a.000/ \$7.000 \$207.13-5.000 1. Wildcat Oil should select project D.560/ \$5.60 1. Hirt.850/ \$8. Year 1 3 6 9 Profits: Expected Value 90 120 150 200 Sensor Technology Standard Deviation 31 52 83 146 Coefficient of Variation . Stocks Bonds Commodities Options Tim Trepid & Mike Macho Coefficient of variation \$4.57 \$1.34 .000 0. which has the greatest risk.000 Wildcat Oil & Richmond Coefficient of variation 0. which has the least risk. b. • Block. Richmond Construction should select project A.000/ \$125.000 0.000 1.26 \$8. Yes. which have the least risk.31 \$15.100/ \$12. the risk appears to be increasing over time.73 b.000 \$108. a.000/ \$262.43 . 13-6. which have the greatest risk. Mgt.

249 169 2.50 561. • Block.2 \$10 80 .3 . Mgt.5 .13-8.976 = 94.20 .5 .4 (D– D )2P \$320 40 360 \$720 σ = 720 = 26.74 Foundations of Fin.984 P .198.2 (D– D )2P \$974.26 Alternative 3: D D \$80 \$172 200 172 400 172 (D– D ) \$-92 +28 +228 (D– D )2 \$8.00 5. Hirt.3 \$27 160 .4 32 120 .621 = 40. S-430 8/E Cdn.976.464 784 51. Alternative 1 D × P = DP \$50 . Short .4 .83 Alternative 2: D D \$90 \$147 160 147 200 147 (D– D ) – 57 + 13 + 53 (D– D )2 3.5 80 200 .00 σ = 8.40 \$8.385.4 \$32 200 .1 40 D = \$172 (D– D ) – 40 – 10 + 30 (D– D )2 1.600 100 900 P .5 100 400 .621.70 84.4 48 D = \$90 Standard Deviation: Alternative 1: D D \$50 90 80 90 120 90 Three Investment Alternatives Alternative 2 D × P = DP \$90 .4 .809 P .1 (D– D )2P \$3.00 σ = 1.80 \$1.60 392.2 40 D = \$147 Alternative 3 D × P = DP \$80 .

26 Alternative 2 (V ) = = = 0.74 = 0. Mgt.298 90 94.Rank by Coefficient of Variation: least risk to most σ 40. • Block.551 172 (V ) = σ Foundations of Fin. S-431 8/E Cdn.83 = 0. Short .274 147 D Alternative 1 Alternative 3 (V ) = σ D D = = 26. Hirt.

20 .3354 Site A is the preferred site since it has the smaller coefficient of variation.40 .10 σ = 1.10 .600 0 1.000 (D– D )2P \$ 240 50 120 500 \$ 910 D \$120 120 120 120 (D– D ) \$40 10 +20 +100 P .20 . A will be just as profitable as B but with less risk.17 Site B D \$50 80 120 160 190 (D– D )2 \$4.30 .600 100 400 10. Because both alternatives have the same expected value.600 4.17/\$120 \$40.15 . Mgt. • Block.620 = \$40. S-432 8/E Cdn.900 1.05 σ = 910 = \$30. Short . Bridget’s Modeling Studios Standard Deviations of Sites A and B Site A D \$80 110 140 220 (D– D )2 \$1. the standard deviation alone would have been enough for a decision.900 (D– D )2P \$ 490 320 0 320 490 \$1.25 VA VB = = \$30.25/\$120 = = .620 D \$120 120 120 120 120 (D– D ) \$70 40 0 +40 +70 P .2514 .50 . Foundations of Fin.13-9. Hirt.

041 Year 1 2 3 4 5 Cash flow \$16.000 22.635 22. Payne Medical Labs Product 2 PV@10% \$22.041 90.000 \$ 19. • Block. the project should be undertaken.000 4 31. S-433 8/E Cdn. but has a lower NPV because of the higher discount rate.13-10.000 versus \$143.000 5 19. 13-11. Short .287 90.913 16.168 13.173 11.798 \$109.200 50.727 24.000 34.000 PV of cash flows Investment NPV PV@12% \$ 8. Hirt.000 70.550 21.000 \$ 14. Product 1 Year Cash flow 1 \$25.618 54.200 Based on a positive NPV.000 29.566 12.000 18.000 3 38.356 16.000 16.581 34.000 12.812 10. Year 1 2 3 4 5 Cash flow \$ 9.000 PV@15% \$13.000 2 30. Micro Systems The coefficient of variation suggests a discount rate of 12%. Mgt.793 28.802 \$104.000).000 PV of Inflows Investment NPV Select Product 1 The instructor may wish to point out that Product 2 has higher undiscounted total cash flows than Product 1 (the numbers are \$171.000 24.000 \$ 4.287 Foundations of Fin.036 9.

Short . NPV (Net Present Value) \$6.160 (%i = 11%.000 %i =? %i = 7.4 .800 × × × × P . Foundations of Fin. The answer assumes that Debby’s probability distribution of the possible outcomes is accurate.400 9. Hirt. • Block. S-434 8/E Cdn.767 25.000 \$(2.13-12.3 . n = 5) = \$22.767 \$ 22.1 \$ 720 1. Debby’s Dance Studios a. Mgt.38% FV = 0 N=5 PMT = \$6.160 b.2 . Expected Cash Flow Cash Flow \$3.000 7. Debby should not buy this new equipment because the net present value is negative and the internal rate of return is less than the cost of capital.960 980 \$6.160 c.500 2.233) Present value of inflows Present value of outflows Net present value IRR (Internal Rate of Return) Calculator: Compute: PV = \$25.600 5.

112 \$2.723. Silverado Mining Company a.768 \$2. S-435 8/E Cdn.380 \$2.951. Foundations of Fin.620) Reject the Yukon Mine.254 \$2.690. • Block.000 16-25 \$800.000.000.000 Present value of inflows Present value of outflows NPV (Net present value) Present Value @ 10% \$1.176.423 \$1.400.13-13. Short . The Yukon Mine Years Cash Flow 5-15 \$400. Mgt.957 \$ 493. b. Recalculate the NPV of the Yukon Mine at a 15% discount rate. Calculate the net present value for each project.774.000 \$ 323.486 \$1. The Yukon Mine Years Cash Flow 5-15 \$400. Select the Yukon Mine if projects are mutually exclusive. Purchase the Labrador Mine.000 \$ 951.000 Present value of inflows Present value of outflows NPV (Net present value) The Labrador Mine Years Cash Flow 1-25 \$300. Hirt.000 Present value of inflows Present value of outflows NPV (Net Present Value) Present Value @ 15% \$1.112 \$2.000 16-25 \$800.196.723.112 Both projects are attractive based on positive NPVs.254 Present Value @ 10% \$2.000 \$ (309.

Mgt.10 30 .30 35 .40 50 . Hirt.13-14.30 60 .10 (D– D )2P \$90 20 0 30 40 \$180 σ = 180 = 13.20 . a.42 = 0.42 thousands Coefficient of variation (V ) = σ D = \$13.30 50 .336 \$40 Foundations of Fin. Then the coefficient of variation.20 Expected cash flow (thousands) DP \$2 9 14 10 \$35 DP \$1 6 12 15 6 \$40 b. S-436 8/E Cdn. Find the standard deviation.20 40 .10 Expected cash flow (thousands) Mr.30 .10 . D \$10 30 40 50 60 D \$40 40 40 40 40 Wrigley Village (D– D ) (D– D )2 \$30 \$900 10 100 0 0 +10 100 +20 400 P . Wrigley Village D P 10 .30 . Short . • Block. Monty Terry D = ∑ DP Crosley Square D P 20 .10 30 .

he should accept Crosley Square because it has a higher net present value. they both should be undertaken. If these two investments are mutually exclusive.336 vs. Hirt. With V = 0. Mr. If the investments are non-mutually exclusive and no capital rationing is involved.870 \$373.000 \$336. Monty Terry (Continued) a. Wrigley Square has more risk (0.5 7.247 \$35 Based on the coefficient of variation.0 σ = 75 = 8.40 . • Block. 0. Short . Mgt. discount rate = 11% discount rate = 8% \$40.10 . Foundations of Fin.617 Expected cash flow IFPVA (n = 25) Present value of inflows Present value of outflows Net present value b.000 \$35.617 300.000 \$ 73.247.336.30 .66 thousands Coefficient of variation (V ) = σ D = \$8.870 300.0 \$75. 13-15.D \$20 30 35 50 D \$35 35 35 35 Crosley Square (D– D ) (D– D )2 \$15 225 5 25 0 0 +15 225 P . S-437 8/E Cdn.5 0 45.66 = 0. Risk-adjusted net present value Wrigley Village Crosley Square With V = 0.20 (D– D )2P 22.247).000 \$ 36.

Hirt. S-438 8/E Cdn.000 105.000 (125.60 . a.000 Fantastic Moderate Dismal .000 110.20 130.20 .000 0 \$125. there is more risk in this alternative so further analysis may be necessary.000 20. is in the Cashmere sweater line.000 85.20 \$180.40 .000 .000) \$21.000 230.000 110. Short .000 \$175.40 \$300.000 125. Foundations of Fin.000) \$41.000 12.13-16. Mgt.000 \$110. However. It is not an automatic decision. The indicated investment.000) Expected NPV b. based on the expected NPV.000 (5.000 (25.000 (5) (3) – (4) \$70. • Block.000 21.000) Expected NPV (6) Expected NPV (2) × (5) \$14.000 \$70. (1) Expected Sales Fantastic Moderate Dismal Enter Wool Sweater Line Enter Cashmere Sweater Line Allison’s Dresswear Manufacturers (2) (3) (4) Present Value of cash flows Probability from sales Initial cost .000 125.000 (50.

13-17.5 σ 0. \$28.000 − \$8.000 \$32.000 Compare to expected value: \$32.5000 .3413 or \$8.000 − \$40. Short .000 expected value + 1 σ 0.000 = = −1 This represents 0.000.000 to \$48.6826 = 68. • Block.000 to \$52.000 expected value + 1.8664 = 86. Probability calculations Expected value = \$40. Hirt. σ = \$8. Mgt.64% c.000 \$8.13% Foundations of Fin.000 a. greater than \$32.8413 = 84.3413 . \$32.000 34% Total distribution under the curve: . S-439 8/E Cdn.26% b.

000 \$8.000 − \$40.5000 .5 This represents 0.000 − \$40.4750 . Less than \$55. Hirt.000 \$12.1587 + 0.000 = = +1.000 \$52.000 \$8.680 = = +1. • Block.0668 = 0.000 − \$8. Less than \$32. in the tails: 0.000 or greater than \$52.55% Foundations of Fin.000 \$32. Total distribution under the curve: .000 Total distribution under the curve.000 = = −1 \$8.000 \$15.9750 = 97.50% e.000 This represents 0.680 − \$40. Short .000 \$8.3413 = 0.000 48%. Mgt.680 \$55.000 Compare to expected value: \$32.3413 or 34% \$52.5000 – 0. S-440 8/E Cdn.4332 = 0.5000 – 0.96 This represents 0.4750 or \$8.d.2255 = 22.680 Compare to expected value: \$55.4332 or 43% \$8.

14 Standard deviation: year 10 D 30 60 90 D 60 60 60 (D– D ) – 30 0 + 30 (D– D )2 900 0 900 P .30 (D– D )2P 270 0 270 540 σ = 540 = 23.40 .60 . Hirt.30 .20 .25 (D– D )2P 100 0 100 200 σ = 200 = 14. The Palo Alto Microchip Corporation (D– D )2 100 0 100 (D– D )2P 20 0 20 40 a. Mgt.24 Foundations of Fin. Standard deviation: year 1 D 50 60 70 D 60 60 60 (D– D ) – 10 0 + 10 P .25 . S-441 8/E Cdn.32 Standard deviation: year 5 D 40 60 80 D 60 60 60 (D– D ) – 20 0 + 20 (D– D )2 400 0 400 P .50 . Short . • Block.20 σ = 40 = 6.13-18.

Risk over time Foundations of Fin. Mgt. • Block.b. Short . Hirt. S-442 8/E Cdn.

386 (3) PVIF Difference . PV @ 10% \$ 54.0 \$ 4.909 . This is one of the consequences of using progressively higher discount rates to penalize for risk. future uncertainty is being penalized by a lower present value interest factor (PVIF).952 . Mgt. Short .228 d. S-443 8/E Cdn.614 (2) PVIF 10% . e.5 37.163 . Table: Year (1) PVIF 5% 1 5 10 .1 \$114.3 23.9 Foundations of Fin. • Block. In effect.c.043 . NPV Year 1 5 10 Inflow \$60 60 60 PV of inflows Investment NPV Accept the investment. Hirt.784 . Yes.9 110.621 . The larger risk over time is consistent with the larger differences in the present value interest factors (PVIFs) over time.

3 VToy = \$6/ \$10 = 0. its negative correlation coefficient of – 0. Students may or may not calculate the coefficient of variation to get some idea about the riskiness of each project.7 Although the Jewelry Company has the highest risk as measured by the coefficient of variation.6 should provide the best risk reduction for Gifford Western Wear. Gifford Western Wear a.6 VBC = \$5/ \$10 = 0. Hirt. its selection would provide the least amount of risk reduction. If they do. c. Since the Boot Company is most like Gifford Western Wear. b. This is an example of a risky company being added to a portfolio but reducing total risk. • Block. You might also want to know more about the relationship of the other companies to each other. The Toy Company offers the next best risk reduction after the Jewelry Company because of its low positive correlation coefficient.5 VJC = \$7/ \$10 = 0. Therefore. Buy the Jewelry Company. they will find the following: VGWW = \$3/ \$10 = 0.13-19. Purchase of the Toy Company would provide some reduction in risk because of the low correlation with Gifford Western Wear. add the Toy Company to the Jewelry Company selected in part (b). A combination with the Jewelry Company would provide a fairly large degree of risk reduction. Mgt. while purchase of Boot Company would do very little to reduce portfolio risk because of the high correlation coefficient. S-444 8/E Cdn. Foundations of Fin. Short .

the coefficient of variation is more than twice as high (.388 40 Expected value 43. The same type of Foundations of Fin.13-20. it doesn’t appear desirable. The share price may actually go down.2 (\$ millions) Coefficient of variation 0.49 Coefficient of variation After the acquisition: (V ) = σ D = 15. • Block. Hopper Chemical Co. c.30 P DP 6 16 18 \$40(\$ millions) σ = ∑ (D − D ) P 2 D \$20 40 60 D 40 40 40 (D– D ) – 20 0 + 20 (D– D )2 400 0 400 P . No.0 (\$ millions) Standard deviation 27. Probably not. Since petroleum is used as part of the firm’s production process.633 b. Although the expected value is \$3 million higher. 388). Before acquisition: D \$20 . D = ∑ DP a. d. an increase in the price of oil would normally hurt the chemical company.40 60 .30 40 .49 = 0.30 . The oil company may provide the best diversification benefits. Short . The slightly added return probably does not adequately compensate for the added risk. Mgt. Hirt. There may be a higher discount rate applied to the firm's earnings to compensate for the additional risk. S-445 8/E Cdn. but this would be offset by the increased profits for the oil company.633 vs.30 (D– D )2P 120 0 120 240 σ = 240 = 15.40 .

offsetting risk reduction benefits would take place if the price of oil were going down. Short . S-446 8/E Cdn. • Block. Mgt. Hirt. Foundations of Fin.

041 × 0.031 × 0.6 c.4 2 × 0. Investment D is riskier by itself with the higher standard deviation (5. Investment N is riskier by itself with the higher standard deviation (3.039 2 + 2 × 0.084 = . σ DE = 0.1%). D = 0.1%).18 + 0.55 × 0. 0.066 + 0.15% σ DE = 0.9% vs.4 × 0.0412 + 2 × 0. D = 0.45 × 0. Β = 0.0400081 = 4.45 c.4 × 0. b. b.052 × 0.0% d.25 + 0.156 = 15. 0.064 e.14 = 0. S-447 8/E Cdn.039 × 0.13-21. 3.19 = 0.6% σ DE = 0. and D is also riskier in a portfolio context as its beta is higher (1.0855 = . Beta is an easier calculation of risk than the portfolio standard deviation.94 = 1.79% d. Jimmy a.94).0312 + 0.85 = 1. Mgt.027897 = 2. Β = 0. However M is also riskier in a portfolio context as its beta is higher (1. The key variable in determining the portfolio standard deviation is the correlation coefficient (how the two investments move together).45 × 0. 4.1525 e.85).55 2 × 0.40+ 0.55 × 0.6 2 × 0. • Block.6 × 0.45 2 × 0.55 × 0.1515 = 15. Astrid a.072 + 0.55 × 1.4 × 1.30 × 0. Short .25 vs. The standard deviation of the portfolio is less than either investment individually.40 vs. Foundations of Fin.2% vs. The standard deviation of the portfolio is less than either investment individually. The portfolio beta is an easier calculation of risk than the portfolio standard deviation.12 + 0. σ DE = 0.60 × 0. The key variable in determining the portfolio standard deviation is the correlation coefficient (how the two investments move together).052 2 + 0. Hirt. 13-22.

20 0. • Block.50 D .20 2 = 20% σ = ∑ (D − D ) P D – 0.30 .10 .232 = 23.03 . Short .30 DP –.20 (D– D ) – .027 .03 .08 .15 .40 .20 0.30 (D– D )2P 0 0 0 0 σ = 0 = 0 = 0% Foundations of Fin.30 (D– D )2P .30 . Mgt.40 .20 .13-23.10 .10 D .20 .10 0.10 0.10 0.40 .10 0.30 (D– D )2 .40 .30 .10 0.054 = .10 P .027 0 .10 = 10% σ = ∑ (D − D ) P D 0. Hirt.30 .10 0.10 (D– D ) 0 0 0 (D– D )2 0 0 0 P .30 .09 0 . S-448 8/E Cdn.30 2 DP .09 P .2% China D 0.00 . Albert Albert & China Projects D = ∑ DP D – 0.03 .054 σ = .04 . a.50 P .

10 – 0.b. Mgt. Short .10 – 0.10 + 0.0% σ AC = 0.5)2 (0) + 2(0)(. S-449 8/E Cdn.50 – 0.62% Foundations of Fin.10 = 0.10 .15 = 15. Hirt.10 – 0.10 .10 – 0.05 = . (D– D ) – 0.0135 σ AC = 0.20 – 0.40 0. σ2AC = (.50 × 0.10 0.50 × 0.10 × covAC = (D (F– ) × P 0.30 0.10 0.5)2(. • Block.30 covAC = 0 Ƿ=0 D i) (F ) 0 0 0 0 c.5) σ2AC D = 0.1162 = 11.10 .5)(.20 + 0.054) + (.

0005625 .40 .40 .40 .25 0. S-450 8/E Cdn.10 DP .0005625 .25 D .000625 – .40 .025 .0403 = 4.175 .060 .000625 – .005625 P .0002500 .010 .40 .080 .25 0.0002500 .20 0.15 0.20 0.20 0.10 (D– D )2P . Alpha Alpha & Omega Projects D = ∑ DP D 0. Hirt.175 2 = 17.10 P .20 0. Mgt.13-24.10 .010 .0005625 .0016250 σ = .25 D = ∑ DP P .025 .175 .000625 .025 .03% Omega D 0.075 .10 (D– D )2P .175 .000625 . • Block. Short .0002500 .025 .40 .175 (D– D ) (D– D )2 .15 0.080 .0016250 Foundations of Fin.10 D .005625 .025 .10 .10 DP .10 0.40 .0016250 = .175 .075 .175 .060 .40 . .5% σ = ∑ (D − D ) P D 0.0005625 .005625 – .175 (D– D ) (D– D )2 – .075 .025 .10 .10 0. a.075 .10 .0002500 .005625 P .175 .15 0.15 0.5% σ = ∑ (D − D ) P D 0.175 2 = 17.

0875 + 0.0403 × 0. (D– D ) 0.175 + 0.175 0.0016250/ 0.0 c. Short . D = 0.0002500 – .001625) + (.5)2(.0016250)(.175 = 0.0005625 – .5)2 (001625) + 2(– .0403 = 4.10 – 0.σ = .175 .50 × 0.5)(.20 – 0.5% σ2AC = (.40 0.10 – 0.175 . • Block.25 – 0.0403 = –1.175 × covAO = (D (F– ) × P 0.50 × 0.15 – 0.03% b.10 D i) (F ) – .175 0. Mgt.20 – 0.0875 = .0005625 – .5) σ2AC σ AC = 0 σ AC = 0 = 0% Foundations of Fin.0002500 – . Hirt.20 – 0.175 0.10 0. S-451 8/E Cdn.175 = 17.0016250 covAO = 0 Ƿ = – .175 .0016250 = .40 0.175 .15 – 0.

Foundations of Fin. Hirt. S-452 8/E Cdn. Return (percent) 17 Mr. Allow the lowest possible risk at a given return level. Short . d. b.13-25. Mgt. a. Achieve the highest possible return for a given risk level. No. Boone H 16 15 14 13 12 11 B C D F G E 10 0 1 A 2 3 4 5 6 Risk (percent) 7 8 c. Each investor must assess his or her own preferences about their risk and return trade-off. • Block.

Short . S-453 8/E Cdn.Foundations of Fin. Mgt. • Block. Hirt.