Lulwa Hassan wishes to estimate the value of an asset expected to provide cash inflows of US$3,000 per year at the end of years 1 through 4 and US$15,000 at the end of year 5. Her research indicates that she must earn 10 percent on low-risk assets, 15 percent on average-risk assets, and 22 percent on high-risk assets.
a. Determine what is the most Lulwa should pay for the asset if it is classified as (1) low-risk, (2) average-risk, and (3) high-risk.
b. Suppose Lulwa is unable to assess the risk of the asset and wants to be certain she's making a good deal. On the basis of your findings in part a, what is the most she should pay? Why?
c. All else being the same, what effect does increasing risk have on the value of an asset? Explain in light of your findings in part a.