Question

A		B		C
Prob	Outcome %	Prob	Outcome %	Prob	Outcome %
0.4	3	0.1	5	0.1	5
0.3	4	0.2	6	0.1	7
0.1	6	0.1	8	0.2	8
0.1	7	0.2	9	0.2	9
0.1	9	0.4	10	0.4	11

Using the following information, which investment would be most preferred using Roy's safety first criterion, if R_L=7%.

		Either B or C (indistinguishable)
		Only B
		Only A
		Either A or B (indistinguishable)
		Only C
		Either A or C (indistinguishable)

Answer 1

The correct answer is option 1.

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The expected return on investment A = 0.4 3% + 0.3 4% + 0.1 6% + 0.1 7% + 0.1 9%

Expected return on investment A = 4.6%

Expected return on investment B = 0.1 5% + 0.2 6% + 0.1 8% + 0.2 9% + 0.4 10%

Expected return on investment B = 8.3%

Expected return on investment C = 0.1 5% + 0.1 7% + 0.2 8% + 0.2 9% + 0.4 11%

Expected return on investment C = 9%

Explanation:- If the investments are not mutually exclusive, the firm must make investments in either B or C as both the investments have an expected return greater than the MARR of 7%