Simonsig Limited is attempting to make a choice between two projects based on the measure of the riskiness. The projects have the following expected cash flows in the next 5 years: Year Project A Project B 1 R900 000 R900 000 2 R800 000 R500 000 3 R400 000 R400 000 4 R300 000 R300 000 5 R200 000 R100 000 Required: 3.1 Establish, using the standard deviation of cash flows as a measure of risk, which project is riskier. (5) 3.2 Establish, using the co-efficient of variation of cash flow as a measure of risk, which project is riskier. (5) 3.3 Explain what measure of risk you would prefer. (2) 3.4 The primary difference between the standard deviation and the co-efficient of variation as measures is: a) The coefficient of variation is easy to calculate b) The standard deviation is a measure of relative risk whereas coefficient of variation is a measure of absolute risk. c) The coefficient of variation is a measure of relative risk whereas the standard deviation is the measure absolute risk. d) The standard deviation is rarely used in practice whereas the coefficient of variation is widely used. (2) 3.5. Investors/companies are considered to be risk……………. Because they expect to be compensated for assuming risk: a) Adverse b) Seekers c) Averse d) Takers
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
QUESTION THREE [16]
Simonsig Limited is attempting to make a choice between two projects based on the measure of the riskiness. The projects have the following expected cash flows in the next 5 years:
Year
Project A
Project B
1
R900 000
R900 000
2
R800 000
R500 000
3
R400 000
R400 000
4
R300 000
R300 000
5
R200 000
R100 000
Required:
3.1 Establish, using the standard deviation of cash flows as a measure of risk, which project is riskier. (5)
3.2 Establish, using the co-efficient of variation of cash flow as a measure of risk, which project is riskier. (5)
3.3 Explain what measure of risk you would prefer. (2)
3.4 The primary difference between the standard deviation and the co-efficient of variation as measures is:
a) The coefficient of variation is easy to calculate
b) The standard deviation is a measure of relative risk whereas coefficient of variation is a measure of absolute risk.
c) The coefficient of variation is a measure of relative risk whereas the standard deviation is the measure absolute risk.
d) The standard deviation is rarely used in practice whereas the coefficient of variation is widely used.
(2)
3.5. Investors/companies are considered to be risk……………. Because they expect to be compensated for assuming risk:
a) Adverse
b) Seekers
c) Averse
d) Takers.
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