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Question
NARRBEGIN: SA_97_98You are considering a 10-year investment project. At present, the expected cash flow each year is $1000. Suppose, however, that each year's cash flow is normally distributed with mean equal to last year's actual cash flow and standard deviation $100. For example, suppose that the actual cash flow in year 1 is $1300. Then year 2 cash flow is normal with mean $1300 and standard deviation $100. Also, at the end of year 1, your best guess is that each later year's expected cash flow will be $1300.
NARREND
Estimate the mean and standard deviation of the NPV of this project. Assume that cash flows are discounted at a rate of 10% per year.
Answer
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NARRBEGIN: SA_101_107The personnel department of a large corporation wants to estimate the family dental expenses of its employees to determine the feasibility of providing a dental insurance plan. A random sample of 12 employees in 2004 reveals the following family dental expenses (in dollars): 115, 370, 250, 93, 540, 225, 177, 425, 318, 182, 275, and 228. Use StatTools for your calculations.NARREND(A) Construct a 90% confidence interval estimate of the mean family dental expenses for all employees of this corporation.(B) What assumption about the population distribution must be made to answer (A)?(C) Interpret the 90% confidence interval constructed in (A).(D) Suppose you used a 95% confidence interval in (A). What would be your answer?(E) Suppose the fourth value were 593 instead of 93. What would be your answer to (A)? What effect does this change have on the confidence interval?(F) Construct a 90% confidence interval estimate for the standard deviation of family dental expenses for all employees of this corporation.(G) Interpret the 90% confidence interval constructed in (E).
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NARRBEGIN: SA_79_80
Auditors of Independent Bank are interested in comparing the reported value of all 1775 customer savings account balances with their own findings regarding the actual value of such assets. Rather than reviewing the records of each savings account at the bank, the auditors randomly selected a sample of 100 savings account balances from the frame. The sample mean and sample standard deviations were $505.75 and 360.95, respectively.
NARREND
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NARRBEGIN: SA_55_62A landowner in Texas is offered $200,000 for the exploration rights to oil on her land, along with a 25% royalty on the future profits if oil is discovered. The landowner is also tempted to develop the field herself, believing that the interest in her land is a good indication that oil is present. In that case, she will have to contract a local drilling company to drill an exploratory well on her own. The cost for such a well is $750,000, which is lost forever if no oil is found. If oil is discovered, however, the landowner expects to earn future profits of $7,500,000. Finally, the landowner estimates (with the help of her geologist friend) the probability of finding oil on this site to be 60%.NARREND(A) Construct a decision tree to help the landowner make her decision. Make sure to label all decision and chance nodes and include appropriate costs, payoffs and probabilities.(B) What should the landowner do? Why?(C) Suppose the landowner is uncertain about the reliability of her geologist friend's estimate of the probability that oil will be found on her land. If she thinks the probability could be anywhere between 40% and 80%, would that change her decision?(D) Suppose that, in addition to the uncertainty about the probability of finding oil, the landowner is also uncertain about the cost of the exploratory well (could vary +/- 25%) and the future profits (could vary +/- 50%). To which of these variables is the expected value most sensitive?(E) What does the risk profile show about the relative risk levels for the landowner's two options?(F) Suppose the landowner suspects that she may be a somewhat risk-averse decision maker, because the she doesn"t feel there is as much of a difference between the two options as their expected values would indicate. She consults with a decision analysis expert who asks her to decide between two hypothetical alternatives: 1) a gamble with equal probabilities of winning an amount $X and losing an amount "$X/2, and 2) doing nothing, with a payoff of $0. The point at which she cannot decide between 1) and 2) is when X=$1,500,000. What is her risk tolerance if she uses an exponential utility function to model her preferences?(G) Apply the risk tolerance given in your answer to the previous question to the landowner's decision tree in (A). What is the optimal decision in this case? What is the resulting certainty equivalent?(H) If the landowner could hire an expert geologist prepare a report to help her make her decision, what is the most that information could be worth? Assume the geologist's information is perfectly reliable.
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