JNTU Financial Risk in Business Questions

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Question 1:

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We, Executives of the F & H company, reviewing complaints from the investors about the company’s slow growth of profits and dividends.

Unlike those doubters, we have confidence in the long-run demand for mechanical encabulators, despite competing digital products. We are, therefore, determined to invest to maintain our share of the overall encabulator market.

F&H has a rigorous CAPEX approval process, and we are confident of returns around 8% on investment. That’s a far better return than F&H earns on its cash holdings. The CFO went on to explain that F&H invested excess cash in short-term U.S. government securities, which are almost entirely risk-free but offered only a 4% rate of return.

Please answer the following questions in detail, provide examples whenever applicable, support your argument with citing peer-reviewed sources.

  • Is a forecasted 8% return in the encabulator business necessarily better than a 4% safe return on short-term U.S. government securities? Justify why or why not?
  • Is F&H’s opportunity cost of capital 4%?
  • How in principle should the CFO determine the cost of capital?

Question 2

Several years ago, The Wall Street Journal reported that the winner of the Massachusetts State Lottery prize had the misfortune to be both bankrupt and in prison for fraud. The balance of the prize was $9,420,713, to be paid in 19 equal annual installments (There were 20 installments, but the winner had already received the first payment). The bankruptcy court judge ruled that the prize should be sold off to the highest bidder and the proceeds to be paid to the creditors.

  • If the interest rate was 8%, how much would you have been prepared to bid for the prize?
  • Enhance Reinsurance Company was reported to have offered $4.2 million. Find the return that the company was looking for.

Please review at least 2 peer reviwed articles and explain your answer in detail and provide in-text citations.


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