12 economics questions…answers must be complete and original due by

Salvatore 14: Discussion Question 12 What is the rationale behind the minimax regret rule? What are some less formal and precise methods of dealing with uncertainty? When are these useful? ANSWER: Your answer goes here     Salvatore 14: Discussion Question 15 How does the adverse selection problem arise in the credit- card market? How do credit- card companies reduce the adverse selection problem that they face? To what complaint does this give rise? ANSWER: Your answer goes here     Salvatore 14: Spreadsheet Problem 1 An individual has to choose between investment A and investment B. The individual estimates that the income and probability of the income from each investment are as given in the following table:

Investment A
Investment B

Income Probability
Income Probability
4000            0.2           4000
0.3
5000            0.3           6000
0.4
6000            0.3           8000
0.3
7000             0.2

(a) Using Excel’s statistical tools, calculate the standard deviation of the distribution of each investment. (b) Which of the two investments is more risky? (c) Which investment should the individual choose?

NOTE: Use table 14-4 as reference
ANSWER: Your answer goes here     Salvatore 14: Spreadsheet Problem 2 An individual is considering two investment projects. Project A will return a zero profi t if conditions are poor, a profi t of \$ 4 if conditions are good, and a profi t of \$ 8 if conditions are excellent. Project B will return a profi t of \$ 2 if conditions are poor, a profi t of \$ 3 if conditions are good, and a profi t of \$ 4 if conditions are excellent. The probability distribution of conditions is as follows:

Conditions: Poor Good Excellent
Probability: 40% 50% 10%

(a) Using Excel, calculate the expected value of each project and identify the preferred project according to this criterion. (b) Assume that the individual’s utility function for profit is
U(X) = X – 0.05X2. Calculate the expected utility of each project and identify the preferred project according to this criterion. (c) Is this individual risk averse, risk neutral, or risk seeking? Why?

NOTE: Use tables 14-5 and 14-6 as reference
Employee Value     Probability

\$50,000                0.25

\$60,000                0.25

\$70,000                0.25

\$80,000                0.25

What is the expected value of five employees you hire?

NOTE: Need to consider adverse selection.
ANSWER: Your answer goes here     Salvatore 15: Discussion Question 7 (a) When can the NPV and the IRR methods of evaluating investment projects provide contradictory results? (b) How can this arise? (c) Which method should then be used? Why? ANSWER: Your answer goes here     Salvatore 15: Problem 8 John Piderit, the general manager of the Western Tool Company, is considering introducing some new tools to the company’s product line. The top management of the firm has identified three types of tools (referred to as projects A, B, and C). The various divisions of the firm have provided the data given in the following table on these three possible projects. The company has a limited capital budget of \$ 2.4 million for the coming year. (a) Which project(s) would the firm undertake if it used the NPV investment criterion? (b) Is this the correct decision? Why?

NOTE: Remember the firm has a limited capital budget of \$2.4 million for the coming year. In other words, the firm faces the capital rationing and should use the profitability index as its investment criterion (pp. 637–640).
ANSWER: Your answer goes here     Salvatore 15: Problem 10 The MacBurger Company, a chain of fast- food restaurants, expects to earn \$ 200 million after taxes for the current year. The company has a policy of paying out half of its net after-
tax income to the holders of the company’s 100 million shares of common stock. A share of the common stock of the company currently sells for eight times current dividends.
Management and outside analysts expect the growth rate of earnings and dividends for the company to be 7.5 percent per year. Calculate the cost of equity capital to this fi rm.

NOTE: Use the dividend valuation model (pp. 642–643). “A share of the common stock of the company currently sells for eight times current dividends

ANSWER: Your answer goes here     Salvatore 15: Spreadsheet Problem 1 The benefits and costs of an investment project (the purchase of a piece of machinery) are those given in the following table. In Excel, calculate net revenue, or the revenue from the investment minus the costs; the present value coefficient for every year; and the present value of the net revenue. Add together column F to get the net present value of the project. Should the firm purchase the machine?

NOTE: Change the present value coefficient from 1/(1+0.5)n to 1/(1+0.05)n. That is the discount rate of 5% instead of 50%
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