Probability Analysis. Tex-Mex, Inc. is a rapidly growing chain of Mexican-food restaurants. The company has a limited amount of capital for expansion, and must carefully weigh available alternatives. Currently, the company is considering opening restaurants in Phoenix and/or Tucson, Arizona. Projections for the two potential outlets are:
Each restaurant would involve a capital expenditure of $1.5 million, plus land acquisition costs of $500,000 for Phoenix and $1,050,000 for Tucson. The company uses the 10% yield on riskless U.S. Treasury bills to calculate the risk-free annual opportunity cost of investment capital.
A. Calculate the expected value, standard deviation, and coefficient of variation for each outlet's profit contribution.
B. Calculate the minimum certainty equivalent adjustment factor for each restaurant's cash flows that would justify investment in each outlet.
C. Assuming the management of Tex-Mex is risk averse, and uses the certainty equivalent method in decision making, which is the more attractive outlet? Why?

Question

Probability Analysis. Tex-Mex, Inc. is a rapidly growing chain of Mexican-food restaurants. The company has a limited amount of capital for expansion, and must carefully weigh available alternatives. Currently, the company is considering opening restaurants in Phoenix and/or Tucson, Arizona. Projections for the two potential outlets are:
  Each restaurant would involve a capital expenditure of $1.5 million, plus land acquisition costs of $500,000 for Phoenix and $1,050,000 for Tucson. The company uses the 10% yield on riskless U.S. Treasury bills to calculate the risk-free annual opportunity cost of investment capital.
A. Calculate the expected value, standard deviation, and coefficient of variation for each outlet's profit contribution.
B. Calculate the minimum certainty equivalent adjustment factor for each restaurant's cash flows that would justify investment in each outlet.
C. Assuming the management of Tex-Mex is risk averse, and uses the certainty equivalent method in decision making, which is the more attractive outlet? Why?

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The Answer of Probability Analysis. Tex-Mex, Inc. is a rapidly growing chain of Mexican-food restaurants. The company has a limited amount of capital for expansion, and must carefully weigh available alternatives. Currently, the company is considering opening restaurants in Phoenix and/or Tucson, Arizona. Projections for the two potential outlets are:
  Each restaurant would involve a capital expenditure of $1.5 million, plus land acquisition costs of $500,000 for Phoenix and $1,050,000 for Tucson. The company uses the 10% yield on riskless U.S. Treasury bills to calculate the risk-free annual opportunity cost of investment capital.
A. Calculate the expected value, standard deviation, and coefficient of variation for each outlet's profit contribution.
B. Calculate the minimum certainty equivalent adjustment factor for each restaurant's cash flows that would justify investment in each outlet.
C. Assuming the management of Tex-Mex is risk averse, and uses the certainty equivalent method in decision making, which is the more attractive outlet? Why?