Question

Asset valuation and risk  Personal Finance Problem Laura Drake wishes to estimate the value of an asset expected to provide cash inflows of $3,000 per year at the end of years 1 through 4 and $15,000 at the end of year 5. Her research indicates that she must earn 10​% on​ low-risk assets, 15​% on​ average-risk assets, and 22​% on​ high-risk assets.

a.Determine what is the most Laura should pay for the asset if it is classified as​ (1) low-risk,​ (2) average-risk, and​ (3) high-risk.

b. Suppose Laura is unable to assess the risk of the asset and wants to be certain​ she's making a good deal. On the basis of your findings in part a​, what is the most she should​ pay? Why?

c. All else being the​ same, what effect does increasing risk have on the value of an​ asset? Explain in light of your findings in part a.

Answer 1

Req 1:
value if assets as Low risk
Year	Cash Inflows		PVF @ 10%	Present value
1	3000		0.909091	2727.273
2	3000		0.826446	2479.339
3	3000		0.751315	2253.944
4	3000		0.683013	2049.04
5	15000		0.620921	9313.82
Present value of Asset				18823
Value of Assets as Average risk
Year	Cash Inflows		PVF @ 15%	Present value
1	3000		0.869565	2608.696
2	3000		0.756144	2268.431
3	3000		0.657516	1972.549
4	3000		0.571753	1715.26
5	15000		0.497177	7457.651
Present value of Asset				16023
value of Assets as High risk
Year	Cash Inflows		PVF @ 22%	Present value
1	3000		0.819672	2459.016
2	3000		0.671862	2015.587
3	3000		0.550707	1652.121
4	3000		0.451399	1354.197
5	15000		0.369999	5549.989
Present value of Asset				13031
Req 2: When assets is not assessed, then it must be taken on Average basis.
The maximum price which should be paid by Laura shall be $16023
Req 3:
When the risk increasing, the value of asset will go on decreasing.
This is apparent from the above computation.