Q. What is the range of the rates of return for each of the projects?
Range of RoR = Optimistic minus Pessimistic
For the projects, say
Project X has an optimistic value is 24% and its pessimistic value is 16%.
Therefore, the Range of RoR (Project X) = Optimistic – Pessimistic
Range of RoR (Project X) = 24% - 16% = 8%
Project Y has an optimistic value is 30% and its pessimistic value is 10%.
Therefore, the Range of RoR (Project Y) = Optimistic – Pessimistic
Range of RoR (Project X) = 30% - 10% = 20%
Q. Which project is less risky? Why?
Given that there is no much information on both projects, the range can be used instead as a risk indicator. When the range is increased, then the project is regarded as very risky (Mathews, 2009). Thus, the outcome is regarded as full of uncertainty. Also, when the range is relatively reduced, then the project is of low risk. Thus, the outcome is regarded as very certain. From the information and calculation above, it is indeed true that project Y is very risky as compared to project X. The project that can be recommended with less risky, thus project X as it has more certainty as compared to project Y. Project X has reduced RoR (rate of return), therefore, project X is likely to perform well in any given pessimistic scenario with a reduced RoR of 16% as compared to project Y's 10% RoR.
Q. Which investment would you choose? Why?
I would select project X because the outcome is considered more certain. The lowest return that is expected for the project is 16%. As a result, there is more assurance that reasonable returns would be realized.
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Q. What does your investment choice say about your feelings towards risk?
The case shows that my feeling towards risk is to be a risk averse investor. The preference of either of the projects depends on risk tolerance of the particular investor. Any risky investor would select project Y with higher risk which means higher returns, while a risk averse person would select project X with limited downside and upside.
Q. Assume that expansion Y most likely outcome is 21% per year and that all other facts remain the same. Does this change your investment choice answer? Why?
Even if project Y provides an additional percentage as compared to project X, it is not an optimal choice as it is seen to be riskier than project X. Thus, the case depends on risk tolerance that the investor has. My investment choice remains towards project X because I am focused on downside risk as compared to upside potential. The case means I am risk averse.
Q. What are the ethical considerations that Sky Fly's managers should observe when deciding between the two projects?
Sky Fly’s Managers need to show characteristics that the investment is socially responsible. In essence, the project implementation should enhance the lives of the people in the society. The project should be undertaken in a way that no illegality should occur and that the project needs to be environmentally friendly.
Reference
Mathews, S. (2009). Valuing risky projects with real options. Research-Technology Management, 52(5), 32-41.
