Problem: Jonathon Barrs is a manager for Easy Manufacturing, LLC. He wishes to evaluate three possible investments. These investments are for the purchase of new machine tools from Germany, Japan, and a local US manufacturer. The firm earns 10% on its investments and they have a risk index of 5%. The chart below lays out the expected return and expected risks of the three projects.
|
Investment
|
Expected Return
|
Expected Risk
|
|
German Tools
|
15.00%
|
8.00%
|
|
Japanese Tools
|
13.00%
|
9.00%
|
|
Local Manufacturer
|
11.00%
|
7.00%
|
1) If Jonathon were risk-indifferent, which investments would he select? Explain why.
2) If he were risk-averse, which investments would he select? Why?
3) If he were risk-seeking, which investments would he select? Why?
4) Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?