Financial Management: 16-8 Business and Financial Risk

Financial Management
16-8 Business and Financial Risk
Here are the estimated ROE distributions for Firms A, B, and C:
Probability
             0.1 0.2 0.4 0.2 0.1
Firm A: ROEA 0.0% 5.0% 10.00% 15.0% 20.0%
Firm B: ROEB (2.00) 5.0 12.0 19.0 26.0
Firm C: ROEC (5.00) 5.0 15.0 25.0 35.0

a. Calculate the expected value and standard deviation for Firm C’s ROE. ROEA _10.0%, _A _ 5.5%; ROEB _ 12.0%, _B _ 7.7%.
b. Discuss the relative riskiness of the three firms’ returns. (Assume that these distributions are expected to remain constant over time.)
c. Now suppose all three firms have the same standard deviation of basic earning power (EBIT/Total assets), _A _ _B _ _C _ 5.5%. What can we tell about the financial risk of each firm?
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