Meega Airlines decided to offer direct service from Akron to Clearwater Beach, Florida. Management must decide between full-price service using a company’s new fleet of jet aircraft and a discount-service using smaller capacity commuter planes. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service on Clearwater Beach: high, moderate, and low. The following table shows the estimated quarterly profits (in thousands of dollars):

The prior distribution for the demand is P(High) = 0.3, P(Medium) = 0.5, and P (Low) = 0.2, respectively.

(a) Calculate the expected value of each decision alternative and recommend the best strategy based on the expected value.

(b) Meega Airlines considers market research before making a decision. Market research produces the following posterior distribution of the states of nature. Calculate the expected value of each decision under each market research outcome.

(c) Create a decision tree with the expected value of each decision as a payoff, including branches for each market research outcome and a branch for no market research.

Suppose you are the manager of a mutual fund and hold a RM10 million stock portfolio. The
required market risk premium is 6.5% and the risk fee rate is 3%. Stock A & B are 20% each
of its total portfolio, Stock C and D are 25% and 18% and the remainder goes to Stock E.
Beta for Stock A, B, C, D and E are 0.75, 1.30, 1.6, 0.5 and 1.2. The return for stock A and B
are 25% and 18% while Stock C and D are 12% and 30%. Return for Stock E less 10% than
Stock A.
Randomly you pick two stocks, Stock A & C to look either both of these are positively or
negatively correlated. Before make any decisions either to remain holding in the portfolio or
to sell in the market. You are prefer to maintain those stocks that able to give higher return
and try to minimise the risk.

Required:
a. Compute the expected return of your portfolio.

b. Compute the portfolio beta.


c. Compute the expected return and standard deviation for Stock A & Stock C.


d. Compute the covariance and correlation of Stock A & C.


e. What you find out about your portfolio and from (d). Any suggestion(s)?

Jason Scott has applied for a mortgage to purchase a house, and he will go to settlement in two months. His loan can be locked in now at the current market interest rate of 7% and a cost of $1,000. He also has the option of waiting one month and locking in the rate available at that time at a cost of $500. Finally, he can choose to accept the market rate available at settlement in two months at no cost. Assume that interest rates will either increase by 0.5% (0.3 probability), remain unchanged (0.5 probability), or decrease by 0.5% (0.2 probability) at the end one month.

Rates can also increase, remain unchanged, or decrease by another 0.5% at the end on the second month. If rates increase after one month, the probability that they will increase, remain unchanged, and decrease at the end of the second month is 0.5, 0.25, and 0.25, respectively. If rates remain unchanged after one month, the probability that they will increase, remain unchanged, and decrease at the end of the second month is 0.25, 0.5, and 0.25, respectively. If rates decrease after one month, the probability that they will increase, remain unchanged, and decrease at the end of the second month is 0.25, 0.25, and 0.5, respectively.

Assuming that Jason will stay in the house for 5 years, each 0.5% increase in the interest rate of his mortgage will cost him $2,400. Each 0.5% decrease in the rate will likewise save him $2,400. What strategy would you recommend?

How do you set this up in excel?

Problem 14-1 (All answers were generated using 1,000 trials and native Excel functionality.) The management of Brinkley Corporation is interested in using simulation to estimate the profit per unit for a new product. The selling price for the product will be $45 per unit. Probability distributions for the purchase cost, the labor cost, and the transportation cost are estimated as follows:

(a) Compute profit per unit for base-case, worst-case, and best-case.

Profit per unit for base-case:$

Profit per unit for worst-case: $

   Profit per unit for best-case: $

(b) Construct a simulation model to estimate the mean profit per unit. If required, round your answer to the nearest cent.

   Mean profit per unit = $

(c) Why is the simulation approach to risk analysis preferable to generating a variety of what-if scenarios?

(d) Management believes that the project may not be sustainable if the profit per unit is less than $5. Use simulation to estimate the probability the profit per unit will be less than $5. If required, round your answer to a one decimal digit percentage. %

Greeson Clothes Company produced 23,000 units during June of the current year. The Cutting Department used 4,400 direct labor hours at an actual rate of $13.2 per hour. The Sewing Department used 7,300 direct labor hours at an actual rate of $12.9 per hour. Assume there were no work in process inventories in either department at the beginning or end of the month. The standard labor rate is $13.1. The standard labor time for the Cutting and Sewing departments is 0.2 hour and 0.3 hour per unit, respectively.

a. Determine the direct labor rate, direct labor time, and total direct labor cost variance for the (1) Cutting Department and (2) Sewing Department.. Enter a favorable variance as a negative number using a minus sign and an unfavorable variance as a positive number.

b. The two departments have opposite results. The Cutting Department has a(n) unfavorable  rate and a(n) favorable  time variance, resulting in a total favorable  cost variance. In contrast, the Sewing Department has a(n) favorable  rate variance but has a(n) unfavorable  time variance, resulting in a total unfavorable  cost variance.

A global equity manager is assigned to select stocks from a universe of large stocks throughout the world. The manager will be evaluated by comparing her returns to the return on the MSCI World Market Portfolio, but she is free to hold stocks from various countries in whatever proportions she finds desirable. Results for a given month are contained in the following table:

a. Calculate the total value added of all the manager’s decisions this period. (Do not round intermediate calculations. Round your answer to 2 decimal places. Negative amount should be indicated by a minus sign.)

Added Value=

b. Calculate the value added (or subtracted) by her country allocation decisions. (Do not round intermediate calculations. Round your answer to 2 decimal places. Negative amount should be indicated by a minus sign.)

Contribution of country allocation=

c. Calculate the value added from her stock selection ability within countries. (Do not round intermediate calculations. Round your answer to 2 decimal places. Negative amount should be indicated by a minus sign.)

Contribution of stock selection=

Lola must decide on a price for her homemade aromatherapy candles. The number of candles she expects to sell depends on the price that is set by her competitor, Sunny’s Scents of Serenity. Lola must set her price before she knows what Sunny will do. Lola believes that Sunny’s price is a random variable C having the following probability mass function. P[C =$8]=0.4,P[C=$10]=0.3,P[C=$12]=0.2,P[C=$15]=0.1. IfLolachargesaprice p1 and Sunny charges a price p2, Lola sells 20 + 5(p2 – p1) candles. Lola is considering charging $6, $10, or $12 for her candles. It costs her $1 in time and materials to make each candle.

a. Under the Expected Monetary Value criterion, which price should Lola charge?

b. Lola can bribe Sunny’s boyfriend to tell her what price she (Sunny) plans to charge. At most how much should Lola be willing to pay for this information?

c. Lola is not comfortable with the payout she gets ($405) when she sets her price to $10 and Sunny sets hers to $15. She think it should be higher. How large must it become before the option of setting her price to $10 become optimal on expected monetary value (EMV) grounds?

Suppose that T-bills currently have a rate of return of 2%. As- sume that borrowing is possible at the risk free rate. You are risk averse and you are considering constructing a portfolio consisting of T-bills and one of the two risky assets: Stock A or Stock B. You did the following scenario analysis on stocks A and B

Events Bull Market Normal Market Bear Market

Probability Stock Aís return 0.3 50%
0.5 18%
0.2 -20%

Stock Bís return 10%
20%
-15%

1. (a) Compute the expected rate of return and the standard deviation for Stock A and Stock B.

2. (b) Based on the information you have so far, which of the two risky assets, Stock A or Stock B, would you choose to be included in your portfolio with T-bills? Explain.

3. (c) Your friend is considering the same problem but she is more risk averse than you. Should she arrive at a di§erent conclusion than you? Ex- plain.

4. (d) Suppose that you start your portfolio with $1 million and also your portfolio target risk (std dev) is 10% (this is your portfolio from part (b)), how many dollars will you invest in T-bills? What is your port- folioís expected return? Show your work.

Lafarge is a French industrial company specializing in three major products: cement, construction aggregates, and concrete. Lafarge Zambia operates 2 integrated cement plants (situated in Ndola and Lusaka) with a total production capacity of 1.4 million tonnes per annum. Lafarge Zambia is considering to develop a new plant in the central province of Zambia. The following three options available. These are to open a small plant, a medium-sized plant, or no plant at all. The marketing department has advised that the market for a plant in central province can be good, average, or bad. The probabilities for these three possibilities are 0.2 for a good market, 0.5 for an average market, and 0.3 for a bad market. The net profit or loss figures for the medium-sized and small plant for the various market conditions are given in the following table. Building no plant at all yields no loss and gain.

The above information has been given to you as management accountant of Lafarge.

Required

1. Which of the three options would you recommend and why?

Basing on the minimax regret criterion and the minimum Expected Opportunity loss criterion, which would you recommend? (10 mar