Introduction
Diligent Consulting Group has learnt of various investment opportunities that your investment company could reach out for. The available options for the investment are in Real Estate Development, Just Hats Retail franchise and High Yield Municipal Bonds. Upon meticulous analysis of the required amounts of initial investment relative to the payoffs expected of each investment and based on the decision tree, the consulting group has provided its judicious counsel on the most lucrative investment that promises profitable revenue in addition to assuming reasonable risk.
Real Estate Development
The investment opportunity at Real Estate Development bears the following attributes: a prerequisite initial investment of $750,000 that promising payoffs at $5 million in case of a high Net Present Value (NPV) whose probability is 0.5. Alternatively, there is $2 million investment in case of a Medium NPV whose probability is 0.3 and no payoff at all in the event there is a low NPV whose probability is 0.2. The expected value for the investment in case of a high NPV is $2,500,000. On the other hand, the expected value in case of a medium NPV is $600,000 while the expected value in case of a low NPV is $0.
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Generally, the overall expected value for the investment opportunity at Real Estate Development is $3,100,000. Based on the decision tree, this investment, inclusive of the initial required amount, would result into an aggregate return of $4,250,000 in case of a high NPV, $,1,250,000 in case of a medium NPV and an ultimate loss of $750,000 in case of a low NPV. Although there is great promise in this investment, the investor faces the high risk of not gaining any returns from the investment and ultimately losing the initially staked amount.
Just Hats Retail Franchise
Alternatively, another suitable option would be an investment in the Real Franchise for Just Hats that requires a relatively lower initial investment of $550,000. With regard to the envisaged payoffs, the investment would generate $3 million in the case if a high NPV at a high probability of 0.75, a return of $2 million in case of a medium NPV at a probability of 0.15 and a return of $1 million whose probability is a low 0.1. In addition, the investment holds an expected value of $2.25 million in the event of a high NPV, $0.3 million in the event of a medium NPV and an expected value of $0.1 million in case of a lower NPV. The overall NPV for the investment is $2.65 million.
On aggregate, taking to account the initially staked amount, the investment is expected to return $2.45 million, $1.45 million or $450,000 in the event of a high, medium or low probability respectively. This shows the relatively lower risk attributed to this investment compared to Real Estate Development.
High Yield Municipal Bonds
Otherwise, the investment company could stake $750,000 on the High Yield Municipal Bonds expected to return an absolute $1.5 million, which would be an aggregate $750,000 in return. The overall expected value of the investment stands at $1.5 million as well.
Analysis
Premised on the representation in the decision tree, the expected value in the decision to invest in the Real Estate Development stands at $2,350,000 while the decision to invest in Just Hats investment potentially holds an expected value of $2,100,000. Meanwhile, the decision to invest in High Yield Municipal holds an absolute expectation value of $750,000. In the same vein, it is established that that a decision to make an investment either way holds a potential expected return of $2,350,000 while a decision not to invest at all inevitably holds no investment value.
Premised on the fact that making an investment is already considered the most preferable option, a case in point on investment in the Real Estate Development shows an option that would potentially generate greater returns compared to the other alternatives. However, despite a low probability of 0.2, investment in this alternative bears a potential loss without any returns in the event of a low NPV, which adds to the fact that the initial invested amount is lost. This aspect makes the alternative a high-risk investment decision that promises a very high payoff at a high probability as well. Nevertheless, it is only suitable to the extent that the investment company is willing to risk an absolute loss of their stake.
On the other hand, investment in Just Hats poses a potentially lower risk compared to investment in Real Estate Development. This is attributed to the fact that whichever Net Present Value becomes the case, the investment company would be certain of generating returns from their stake. The decision, however, only bears the risk of generating a lower payoff of $450,000 whose probability is a low 0.1. Similarly, investment in the High Yield Municipal bears no risk at all, as it guarantees a certain return.
Recommendations
Premised on the analysis above, it quite overt that investment in the High Yield Municipal is the most lucrative option because of its relative certainty of returns. However, it would be the judicious counsel of Diligent Consulting group that the investment company considers investment in Just Hats as the most lucrative alternative. This is attributed to the fact that the investment ascertains returns on the initial amount invested promising higher payoffs than High Yield Municipal at high probabilities. As such, the investment company should brave the risk of the investment turning out on a low NPV, which is least probable, since they will still be ascertained of returns on their investment unlike investing in Real Estate Development whose low NPV guarantees loss. This would be a risk, which would not be worth the investment.
References
Levy, H. (2015). Stochastic dominance: Investment decision making under uncertainty. New York: Springer.
Woike, J. K., Hoffrage, U., & Petty, J. S. (2015). Picking profitable investments: The success of equal weighting in simulated venture capitalist decision making. Journal of Business Research, 68(8) , 1705-1716.
