Bus 640 Week 1

Economics of Risk and Uncertainty Applied Problems

[Student Name]

[School]

[Course/Number]

June 12, 2013

[Instructor Name]

ECONOMIC OF RISK AND UNCERTAINITY

1. A generous university benefactor has agreed to donate a large amount of money for student scholarships. The money can be provided in one lump-sum of $10mln, or in parts, where $5.5mln can be provided in year 1, and another $5.5mln can be provided in year 2. Assuming the opportunity interest rate is 6%, what is the present value of the second alternative? Which of the two alternatives should be chosen and why?

5 Million (1.06) = 5.3 Million. This alternative is not feasible because there is gap of 0.2 million between the opportunity cost and the amount save while using alternative.

How would your decision change if the opportunity interest rate was 12%? Please, show all your calculations.

5 Million (1.12) = 5.6 Million. This alternate is most suitable for the generous university because it contain nearly one hundred thousand excess reimbursements as compare to the alternative. So this one alternative is profitable for the Generous University.

2. Volkswagen is considering opening an Assembly Plant in Chattanooga, Tennessee, for the production of its 2012 Passat, tailored for the US market. The CEO of the company is considering two potential options for the size of the plant: one is a large size with a projected annual production of 150,000 cars, and the other one is a smaller size plant, which is cheaper to build, but can only produce up to 80,000 cars per year. Depending on the expected level of demand for these cars in the US, Volkswagen has to decide which option is more profitable. The discount rate is 6% and for simplicity purposes, the CEO is only evaluating a two-year horizon. The initial factory setup cost, the expected demand scenarios, profit, and probabilities are shows in the below table. Calculate the Net Present Value in each of the two options. Which option should the CEO choose and why?...