Jim Jones needs to identify the highest cash flow as well as the risk associated with it from his decision alternatives. He can get numerical evidence to support such claim and be able to be guided according to derived computation. To illustrate:
All UP
Possible Cash
Probability of
(CFx1)(Px1)
(CFx1 – CF1)
Dispersion
Coefficient of
Flow (CFx1)
Occurrence (Px1)
=CF1
squared(Px1)
Variation
5,000
0.20
1,000
2,888,000
3,000
0.40
1,200
1,296,000
-
0.20
-
288,000
(5,000)
0.20
(1,000)
7,688,000
TOTAL
1.00
1,200
12,160,000
approx 3,487
2.91
CG on Helmets
12,000
0.20
2,400
20,808,000
6,000
0.40
2,400
7,056,000
(5,000)
0.20
(1,000)
9,248,000
(10,000)
0.20
(2,000)
27,848,000
TOTAL
1.00
1,800
64,960,000
approx 8,060
4.48
MS on Elctronics
15000
0.20
3,000
40,328,000
7000
0.40
2,800
15,376,000
-10000
0.20
(2,000)
23,328,000
-15000
0.20
(3,000)
49,928,000
TOTAL
1.00
800
128,960,000
approx 11,356
14.20
MM on Phones
30000
0.20
6000
180,000,000
10000
0.40
4000
40,000,000
-20000
0.20
-4000
80,000,000
-30000
0.20
-6000
180,000,000
1.00
0
480,000,000
approx 21,909
#DIV/0!
Without UP
55000
0.20
11000
605,000,000
20000
0.40
8000
160,000,000
-35000
0.20
-7000
245,000,000
-60000
0.20
-12000
720,000,000
1.00
0
1,730,000,000
approx 41,593
#DIV/0!
With highest cash under alternative CG on helmets and UP the rest at 1,800 pounds, he is faced with greater risk or dispersion at approximately 8,060 (risk per unit of expected value at 4.48). On the other hand, sub-optimal cash flow under all UP at 1,200 pounds carries with it lesser risk or dispersion at approximately 3,487 (risk per unit of expected value at 2.90). Other alternatives are illustratively unattractive as they have very minimal cash flow that reach at break-even with a very ambiguous outcome (that is, the computed cash flow/ break-even has relatively larger fluctuations to real-life results). Due to this, Jim Jones has to evaluate his liquidity. If he is liquid, he might choose the alternative CG on helmets and UP the rest. Otherwise, he should choose the less risky all UP. On the other hand, he can minimize the risk of his market assumptions by hiring a research firm. To illustrate (to settle CG on helmets relative risk):
With Research Team to Minimize the Risk
2000
0.20
400
20,808,000
-4000
0.40
-1600
7,056,000
-15000
0.20
-3000
9,248,000
-20000
0.20
-4000
27,848,000
1.00
-8200
64,960,000
approx 8,060
-0.98
As shown by the computation, the deduction of 10,000 pounds for research fee to the expected cash flows aggravates the scenario for CG helmet and UP the rest alternative. The research can be considered futile even though it makes the coefficient of variation less than 1 (in absolute terms) and makes the venture almost risk-free. The same outcome is true when all UP alternative undergo the same process. In effect, there is no other way Jim Jones can maximize his expected cash flow and minimize the risk of the top two alternatives other than his liquidity.
Credit:ivythesis.typepad.com
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