Your friend Jack offers you the opportunity to invest in his new business that sells the...

Your friend Jack offers you the opportunity to invest in his new business that sells the best lemonade in the world, or so he says. Jack says that there is a 60% chance that the investment will be worth $200,000 one year from today, and a 40% chance it won’t be worth anything. If you require a risk premium of 8% and T-bills are currently paying 4% per year, what price will you be willing to pay Jack for the investment?

Multiple Choice

$107,142
$111,111
$178,571
$185,186

Solutions

Expert Solution

Expected future value = 200000 * 0.60 + 0 * 0.40

= 120000

Required return on investment = Risk free rate + Required premium

= 4% + 8%

= 12%

Value of investment today = Expected future value / (1 + Required return)

= 120000 / (1 + 0.12)

= 107142

Correct choice A

jeff jeffy answered 2 years ago

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