You are considering a $500,000 investment in the fast-food industry and have narrowed your choice to either a McDonald's or a Penn Station East Coast Subs franchise. McDonald's indicates that, based on the location where you are proposing to open a new restaurant, there is a 25 percent probability that aggregate 10-year profits (net of the initial investment) will be $16 million, a 50 percent probability that profits will be $8 million, and a 25 percent probability that profits will be -$1.6 million. The aggregate 10-year profit projections (net of the initial investment) for a Penn Station East Coast Subs franchise is $48 million with a 2.5 percent probability, $8 million with a 95 percent probability, and -$48 million with a 2.5 percent probability. Considering both the risk and expected profitability of these two investment opportunities, which is the better investment? Explain carefully.

You are considering a $500,000 investment in the fast-food industry and have narrowed your choice to either a McDonald's or a Penn Station East Coast Subs franchise. McDonald's indicates that, based on the location where you are proposing to open a new restaurant, there is a 25 percent probability that aggregate 10-year profits (net of the initial investment) will be $16 million, a 50 percent probability that profits will be $8 million, and a 25 percent probability that profits will be -$1.6 million. The aggregate 10-year profit projections (net of the initial investment) for a Penn Station East Coast Subs franchise is $48 million with a 2.5 percent probability, $8 million with a 95 percent probability, and -$48 million with a 2.5 percent probability. Considering both the risk and expected profitability of these two investment opportunities, which is the better investment? Explain carefully.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

See similar textbooks

Related questions

Q: A new company is offering its shares for sale in an initial public offering (IPO) through an…

Q: Stock X has a 9.5% expected return, a beta coefficient of 0.8, and a 30% standard deviation of…

A: The required rate of return (RRR) is the minimum return an investor will accept for owning a…

Q: Read the text. Then answer the question that follows. Baylee wants to invest money in a bicycle…

A: Risk is essential to investing; no discussion of returns or performance is complete without at least…

Q: True or False: Increasing the number of stocks in a portfolio reduces firm-specific risk. True…

A: Risks implies to the future uncertainty about the deviation of the earning an individual might earn…

Q: Zhu Manufacturing is considering the introduction of a family of new products. Long-term demand for…

A: EMV (Expected Monetary Value) and EVPI (Expected Value of Perfect Information) are concepts used in…

Q: Assume W(F)=F². Probability of sun is 2/3 and hurricane, 1/3. Plot the IC that runs through Fs,…

A: Utility function : W (F) = F2Probability of Sun = 2/3Probability of Hurricane = 1/3Fs , Fh : (400,…

Q: Assume that you will earn $90,000 next year. The probability of having an accident in a year is 0.05…

A: Expected Utility refers to an economic term summarizing the utility that an organization or…

Q: Shimadzu, a manufacturer of precise scientific instruments, relies heavily on the efforts of its…

A: The optimal managerial compensation contract is portrayed in a climate in which the. administrator…

Q: Two stocks are available. The corresponding expectedrates of return are r¯1 and r¯2; the…

A: According to the above Question we have to find out minimum variance and the mean rate of return of…

Q: Suppose that there is a 20 percent change that George's coffee shop will make $9000 in profits in…

A: Expected profit is the probability of getting a specific profit times the profit, and the expected…

Q: Assume you can invest in 2 projects whose payoff depend on the state of the economy. The profits…

A: Probability of recession is 0.3 and no recession is 0.7.

Q: 17-5. You are offered the following gamble based on coin flips. If the first head occurs on the…

A: In probability theory, the anticipated value is a generalization of the weighted average. The…

Q: company is considering manufacturing 2 mutually exclusive products A and B. Product A is a watch…

A: Net present value (NPV) is the difference between the present worth of cash inflows and the present…

Q: Suppose you visit with a financial adviser, and you are considering investing some of your wealth in…

A: Risk Averse: Someone who avoids taking risks and prioritises safety is said to be risk-averse. They…

Q: An individual’s utility function is given as U (X) = X 0.5 where X represents the money, he has…

A: Intertemporal decision-making in economics refers to a decision-making method that involves matching…

Q: Jones has a utility function u = m0.5. His initial wealth is mo 1000. He is considering Mr. to…

A: The expected value (EV), which is often referred to as mean value, is a metric that is used to…

Q: 8. Risk and return Suppose Frances is choosing how to allocate her portfolio between two asset…

A: An investment is an asset or item obtained determined to create income or appreciation. Appreciation…

Q: You observe the E[IBM] = 8%, E[AAPL] = 12%, B(AAPL)=B(IBM)+2/3, Risk-free rate is 4%. What is the…

A: The expected return is the profit or loss percentage that the investor expects to receive from the…

Q: A manager is deciding whether to build a small or a large facility. Much depends on the future…

A: Game theory in economies studies the strategic interactions among rational decision-makers. It helps…

Q: A ten-year term insurance is be issued to a life aged 50. The sum insured is $200,000 and payable…

A: Annual discounted worth, also known as annual equivalent worth or annualized value, is a financial…

Q: (i) (ii) Please specify the moneyness of the above options. Are they in the money, at the money, or…

A: Given, The price of the stock is $985

Q: Assume that you have all your wealth (one million dollars) invested in the Vanguard 500 index fund,…

A: The term "standard deviation refers to a measurement of the data's dispersion from the mean , if…

Q: 4) Consider investors with preferences represented by the utility function U E(r) – Ao². (a) Draw…

A: An indifference curve (IC) is a graphical representation of various combinations of consumption…

Q: Prospect X = ($4, 0.04 ; $15, 0.05 ; $24, 0.01 ; $38, p) What is the expected value of prospect X?

A: Given prospect Prospect X = ($4, 0.04 ; $15, 0.05 ; $24, 0.01 ; $38, p)

Q: Boom (50%) Recession (50%) -$ 10 Project A $ 20 $ 20 -$ 30 -$ 10 $ 30 $ 50 D. $ 50 hanager adopted…

A: Mean=Total observationNo. of observations The following formula is used to calculate the Variance…

Q: Using the Utility Function in Portfolio Management, where the utility function is the constant…

A: The certainty equivalent is a return that is assured and somebody would prefer to receive now over…

Question

You are considering a $500,000 investment in the fast-food industry and have narrowed your choice to either a
McDonald's or a Penn Station East Coast Subs franchise. McDonald's indicates that, based on the location where you
are proposing to open a new restaurant, there is a 25 percent probability that aggregate 10-year profits (net of the
initial investment) will be $16 million, a 50 percent probability that profits will be $8 million, and a 25 percent
probability that profits will be -$1.6 million. The aggregate 10-year profit projections (net of the initial investment) for
a Penn Station East Coast Subs franchise is $48 million with a 2.5 percent probability, $8 million with a 95 percent
probability, and -$48 million with a 2.5 percent probability. Considering both the risk and expected profitability of
these two investment opportunities, which is the better investment? Explain carefully.

Expert Solution

This question has been solved!

Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.

This is a popular solution!

SEE SOLUTION Check out a sample Q&A here

Step 1: Define investment

VIEW

Step 2: Find expected value

VIEW

Step 3: Compare expected profability

VIEW

Solution

VIEW

Trending now

This is a popular solution!

Step by step

Solved in 4 steps with 7 images

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.

Similar questions

19. An individual has initial wealth Wo = 3 and has the opportunity to invest some quantity of money x in an extremely risky corporate bond. With probability p= 1/4, the bond will be worth 10x at maturity. With probability 1 – p, it will be worth zero. The individual's utility function over final wealth is u(W) = W0.5. What is the level of investment x that maximizes expected utility? (а) 0 (b) 1 (c) 4/3 (d) V3 (e) 2
QUESTION 1 Elizabeth has decided to form a portfolio by putting 30% of her money into stock 1 and 70% into stock 2. She assumes that the expected returns will be 10% and 18%, respectively, and that the standard deviations will be 15% and 24%, respectively. Compute the standard deviation of the returns on the portfolio assuming that the two stocks' returns are uncorrelated. 17.4%. 27.4%. 7.4%. 11.4%. QUESTION 2 Elizabeth has decided to form a portfolio by putting 30% of her money into stock 1 and 70% into stock 2. She assumes that the expected returns will be 10% and 18%, respectively, and that the standard deviations will be 15% and 24%, respectively. Describe what happens to the standard deviation of the portfolio returns when the coefficient of correlation ρ decreases. The standard deviation of the portfolio returns decreases as the coefficient of correlation decreases. The standard deviation of the portfolio returns increases as the coefficient…
Rice farming is risky and generates expected income of $100. The certainty equivalent associated with rice farming will be greater than $100 for a risk averse individual and less than $100 for a risk loving individual. True or False
Hugo has a concave ubility function of U(W)=√W. His only asset is shares in an Internet start-up company. Tomorrow he will learn the stock's value. He belleves that it is worth $225 with probability 80% and $256 with probability 20%. What is his expected utsty? What risk premium would he pay to avoid bearing this risk? The stock's expected utility (EU) is EU = (Enter a numeric response using a real number rounded to two decimal places.) han fro
An investor allocates $30,000 and $50,000 to two assets (A1 and A2). These assets generate 5% and -4.5% rate of returns, respectively. She allocates the remaining 50% of her portfolio to an asset (A3), which provides 4.5% rate of return. Calculate the portfolio's rate of return.
If the risk-free rate is 3 percent and the risk premium is 5 percent, what is the required return?
The value of a successful project is $420,000; the probabilities of success are 1/2 with good supervision and 1/4 without. The manager is risk neutral, not risk averse as in the text, so his expected utility equals his expected income minus his disutility of effort. He can get other jobs paying $90,000, and his disutility for exerting the extra effort for good supervision on your project is $100,000. (a) Show that inducing high effort would require the firm to offer a compensation scheme with a negative base salary; that is, if the project fails, the manager pays the firm an amount stipulated in the scheme. (b) How might a negative base salary be implemented in reality? (c) Show that if a negative base salary is not feasible, then the firm does better to settle for the low-pay, low-effort situation.
Expected utility in portfolio theory
**Practice** In order to alleviate their risks, they are considering a risk-sharing agreement. Carol would buy one CC and David would buy one DD. Six months from now, they would sell their coins, add up the total amount of money, and split it equally between them. Thus, if only one of the coins is successful, they would both still have some positive amount of money at the end. Assume that they can verify whether the other really made the investment. They know whether the investment is successful, since the price of the coin is public information, and they trust that the other will pay them as promised. Which of the following statements is accurate?A. They will not make that risk-sharing agreement.B. Carol is willing to take the risk-sharing agreement, but David is not.C. They may be willing to make that risk-sharing agreement, but it depends on information not given in the question.D. They will surely make the risk-sharing agreement.E. None of the statements above is correct.
An investor has utility function U = 10 + 5P – 0.02P2. What is the expected utility of the following investment option? Probability Payoff (P) 0.4 10 0.3 20 0.2 30 0.1 40
Suppose that there is a 45 percent change that George's coffee shop will make $10000 in profits in January and a 45 percent chance it will make 0 profits and a 10 percent chance that it will make -$1000 in profits (i.e., it will lose $1000). Calculate the coffee shop's expected profits
You plan to invest $1,000 in a corporate bond fund or in a common stock fund. The following table represents the annual return (per $1,000) of each of these investments under various economic conditions and the probability that each of those economic conditions will occur. Compute the expected return for the corporate bond and for the common stock fund. Show your calculations on excel for expected returns. Compute the standard deviation for the corporate bond fund and for the common stock fund. Would you invest in the corporate bond fund or the common stock fund? Explain. If choose to invest in the common stock fund and in (c), what do you think about the possibility of losing $999 of every $1,000 invested if there is depression. Explain.