Module 2 – SLP
RISK: FREQUENCY DISTRIBUTION, PROBABILITIES, AND EXPECTED VALUE
Scenario: You are an entrepreneur that has several business investments in real estate, restaurants, and retail stores. You are looking for your next investment opportunity for you and your private equity investment company. You have found two possible alternatives to invest in that will payoff in the next 10 years. Here are the descriptions of the two options.
Option A: Real estate development. This is a risky opportunity with the possibility of a high payoff, but also with no payoff at all. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.
High NPV: $5 million, Pr = 0.5
Medium NPV: $2 million, Pr = 0.3
Low NPV: $0, Pr = 0.2
Option B: Retail franchise for Just Hats, a boutique type store selling fashion hats for men and women. This also is a risky opportunity but less so than option A. It has the potential for less risk of failure, but also a lower payoff. You have reviewed all of the possible data for the outcomes in the next 10 years and these are your estimates of the Net Present Value of the cash flow and probabilities.
High NPV: $3 million, Pr = 0.75
Medium NPV: $2 million, Pr = 0.15
Low NPV: $1 million, Pr = 0.1
Develop an analysis of these two investments. Use expected value to determine which of these you should choose. Do your analysis in Excel.
Write a report to your private investment company and explain your analysis and your recommendation. Provide a rationale for your decision.
Upload both your written report and Excel file to the SLP 2 Dropbox.
BONUS: If these two options could be made to be equal, what would have to change in the payoffs in Option A to make it equal to Option B (not the investment amount)?
SLP Assignment Expectations
- Accurate and complete analysis in Excel.
- Length requirements = 2–3 pages minimum (not including Cover and Reference pages)
- Provide a brief introduction/ background of the problem.
- Complete and accurate Excel analysis.
- Written analysis that supports Excel analysis, and provides thorough discussion of assumptions, rationale, and logic used.
- Complete, meaningful, and accurate recommendation(s).