Question

Richelieu Specialty Paints has been quite successful and has $1,500,000 cash to be invested. Amanda and her management team have developed four potential investments in addition to leaving the cash in a low-interest deposit. The four new opportunities are:

1. Purchase some shares of a major supplier (25% risk of total loss, 13% potential return)

2. Invest in the research and development of a new product (50% risk of total loss, 60% potential return)

3. Buy a selection of corporate bonds (10% risk of total loss, 6% potential return)

4. Buy a selection of government bonds (1% risk of total loss, 3% potential return)

Leaving the money in a low-interest deposit is virtually riskless and has a 0.5% potential return. Richelieu’s father had provided Amanda with some guidelines for investment, aimed at diversification and risk management. These are:

1. Invest a maximum of 40% of the total cash in any one of the four new opportunities to ensure some risk control.

2. Invest at least $100,000 in each of the four new opportunities to ensure some diversity.

3. Limit the total potential loss, on average, to $300,000, based on the risk factors indicated.

4. Ensure the highest return possible.

Recommend the appropriate mix of the four investments and note how much money, if any, should be left in the low interest deposit. Also, how would this mix change, and what would happen to potential return, if Amanda decided to take a more conservative approach and limit the total potential loss to $150,000.

Answer 1

To recommend the appropriate mix of investments for Richelieu Specialty Paints, we need to consider the guidelines provided by Amanda's father. Based on these guidelines, we can allocate $600,000 to purchasing shares of a major supplier, $600,000 to investing in the research and development of a new product, $100,000 to buying corporate bonds, and $100,000 to buying government bonds. The remaining $100,000 should be left in the low-interest deposit.

Step-by-step explanation:

To recommend the appropriate mix of investments for Richelieu Specialty Paints, we need to consider the guidelines provided by Amanda's father.

1. A maximum of 40% of the total cash can be invested in any one of the four new opportunities, so we can allocate 40% of $1,500,000, which is $600,000, to each opportunity.
2. A minimum of $100,000 should be invested in each of the four new opportunities. Since we have $600,000 allocated to each opportunity, this criterion is satisfied.
3. The total potential loss should be limited to $300,000 on average. Let's calculate the maximum potential loss for each investment option.

• Purchasing shares of a major supplier: $600,000 x 25% = $150,000 potential loss
• Investing in the research and development of a new product: $600,000 x 50% = $300,000 potential loss
• Buying corporate bonds: $600,000 x 10% = $60,000 potential loss
• Buying government bonds: $600,000 x 1% = $6,000 potential loss

The highest return possible should be ensured.

Based on these guidelines, we can allocate $600,000 to purchasing shares of a major supplier, $600,000 to investing in the research and development of a new product, $100,000 to buying corporate bonds, and $100,000 to buying government bonds. The remaining $100,000 should be left in the low-interest deposit.

If Amanda decided to limit the total potential loss to $150,000, we would need to recalculate the maximum potential loss for each investment option.

• Purchasing shares of a major supplier: $600,000 x 25% = $150,000 potential loss
• Investing in the research and development of a new product: $600,000 x 50% = $300,000 potential loss
• Buying corporate bonds: $600,000 x 10% = $60,000 potential loss
• Buying government bonds: $600,000 x 1% = $6,000 potential loss

In this case, the potential loss for investing in the research and development of a new product ($300,000) exceeds the limit. Therefore, Amanda would need to adjust her investment mix to reduce the potential loss and ensure it stays within the limit.