Company XYZ is launching a new product, Product 1. The company’s market analysts
ID: 2744109 • Letter: C
Question
Company XYZ is launching a new product, Product 1. The company’s market analysts determined that there is a 5% chance there will be very strong demand for the new project, a 25% chance the demand will be strong, a 35% chance that demand will be average, a 25% chance it will be below average and a 10% chance of very little demand.
The company’s business analysts determined that if demand is very strong, the investment in the new product will return 150%, if demand is strong the return will be 50%, if it is average it will be 20%, if it is below average the return will be -10% and with a very low demand, the return will be negative 100%.
The Company is also thinking about launching second product, Product 2. The table belowshows the market analyst and business analyst conclusions.
(a) Calculate the expected return for Product 1. Show all work.
(b) Calculate the expected return for Product 2. Show all work.
(c) Is launching one product more risky than launching the other? Explain in detail.
Demand: Product 2 Prob Return Average 65.0% 40.0% Below Average 20.0% 5.0% Very Little 15.0% -100.0%Explanation / Answer
a) Expected return of Product 1 = 14.5% b) Expected return of Product 2 = 12.0% c) Product 2 is more risky as its coefficient of variation is higher. That is, the deviations from the mean are proportionately higher than that for Product 1. Product - 1: deviation Demand Probability - p Return % - R R*p d = R-ER d^2 p*d^2 very strong 0.05 150 7.5 135.5 18360.25 918 strong 0.25 50 12.5 35.5 1260.25 315 average 0.35 20 7.0 5.5 30.25 11 below average 0.25 -10 -2.5 -24.5 600.25 150 very little 0.10 -100 -10.0 -114.5 13110.25 1311 14.5 2705 Expected return = R*p = 14.5% Std. Deviation = p*d^2 = 2705 = 52.01 % Coefficient of variation = SD/Mean (expected return) = 52.01/14.5 = 3.59 Product - 2: deviation Demand Probability - p Return % - R R*p d = R-ER d^2 p*d^2 average 0.65 40 26.0 28.0 784 509.6 below average 0.20 5 1.0 -7.0 49 9.8 very little 0.15 -100 -15.0 -112.0 12544 1881.6 12.0 2401.0 Expected return = R*p = 12.0% Std. Deviation = p*d^2 = 2401 = 49.00 % Coefficient of variation = SD/Mean (expected return) = 49/12 = 4.08
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